Thermo Fisher Scientific Inc. (TMO) Earnings Call Transcript & Summary

All right. Good morning. It's our pleasure to welcome Marc Casper and Ken Apicerno from Thermo to the Cowen Conference. Thermo is one of our favorite large-cap tools stocks. Marc and his team have done a great job creating investor value for well over a decade. For the next 30 minutes, we're going to start by talking about the outlook for 2020; recent developments, including COVID-19; the outlook for China; outlook for your biopharma end market, which is, of course, towards the top of the list of importance for Thermo, at least in our opinion; and then close on the topic of capital deployment. So Marc, thanks for joining us today.

Yes, Doug. Thank you. Nice to see everybody here in Boston. Start out with a brief anecdote. This is the conference that I did my very first investor conference, 18 years ago. And...

Is that right?

It's -- actually, attendance was very thin back then. So it's good to see...

We're growing.

Growth -- the growth over the years. So thank you for having us.

Glad to see you. Glad to have you here.

So let's start by talking about the outlook for 2020 and what you've built into guidance. So just to set this up, you said 2020 organic revenue growth guidance around 5%. This is at the lower end of your longer-term growth target of around 5% to 7%, at least, relative to what was outlined at the recent Analyst Day. On the fourth quarter call, you said you still feel great about end markets, but acknowledged -- you acknowledged there are risks heading into every year, and that these typically dissipate as the year progresses. And if that happens, that gives you an opportunity to bump up expectations, if that's what you see fit. Just to be clear, did you see anything coming out of 2019 in terms of core demand by geography or end market that gave you reason for pause in setting guidance?

Yes. So Doug, thanks for the question. I think it's always good to kind of start with the longer term picture. Right. So '17, '18 and '19, very strong years for our industry, incredibly strong years for Thermo Fisher Scientific, right? So if you start there, '19 was a really good year, 6% organic growth, comparing against an 8% comparison in 2018. We saw great strength across our biopharma presence. We saw good strength across the emerging markets around the world. So it's a strong year and set us up for a guidance where we took the same tact that we've taken over many years, which is, you want to have a starting point with guidance that allows you to deal with the fact that not everything in the world may go well. But if the world is kind of normal, then you have the ability to raise guidance throughout the year. So it was the passed year, and given that our long-term organic growth outlook is 5% to 7%, we started out with 5%. It would have been consistent with the practice of years past. When I thought about year-end finish, the only thing that we looked at as a bit of a headwind was we had a bit of a softer finish in China in the fourth quarter in one portion of our business, which was really very high end, $1 million-plus capital equipment. And there's not a lot of good comparisons to other companies in the field because very few have at that price point. Other than that, across the world, across all businesses, actually, the fourth quarter was fine. And so we didn't really see a lot as we went through the year. When we gave our guidance, we didn't talk about other than the -- coronavirus is just starting to become in -- a topic, and therefore, our guidance didn't have any factor around coronavirus. So that kind of sets the landscape of the last 3 years, kind of from a top line and how we thought about going into the year on guidance and so forth.

So yes, perfect segue to COVID-19, which, of course, is going to be on our topic list here. It's going to be high on the list of questions that we ask everybody about this week. What are you -- can you provide any update? What are you seeing in your business?

Yes. So let me start with a high-level view. I mean I'm happy if you want to delve into more, we can go back and forth a little bit on it as well. So the high-level view is from the lens of our management team, you start out with employee safety, right? And you just say, all right, let's make sure that we're doing the right things to protect our colleagues around the world, right? So that's the first lens. That's an obvious lens. It's a little bit more nuanced in a business like ours, because we're so involved in enabling our customers to make the world a healthier place. That sometimes, it means we're actually having to deal with some of the issues more directly. And I guess to the second thing, which is what is our role from a societal standpoint in addressing coronavirus? We have been so focused on helping governments and hospitals address it, you've seen -- actually, we've been silent on it externally. But actually, we're right in the middle of helping public health organizations address it, and that's really something we can talk more about but incredible amount of activity in terms of what we do in terms of helping address the virus. And then the third aspect is what do you do from a business perspective, right? And how do we think about it? I always view -- we have a very experienced management team. And in any time of uncertainty, the experienced teams that know the goal is to come out of a period of uncertainty a stronger player. That's the guiding principle, right? And so we're going to manage the business appropriately. And that means that we'll capitalize on the opportunities that exist, and we will manage the risks very aggressively as well to make sure that we have a bright future and come out as a stronger player. So that's kind of the philosophy of how we thought about it.

So that's really helpful. Let's dig in a little deeper. So on, I guess, on the role you're playing to help the governments, U.S. and China and others in addressing the challenge. Thermo, I believe, is prominently involved working with the CDC to develop a testing kit. Could you talk a little bit about that in the broader role that Thermo is playing right now?

Yes. So if you think about the role -- first of all, it starts actually with our channel business, right? And we are a large provider of personal protection equipment. And so we are aggressively working to make sure that product, masks, PPE's in the right places around the world. So that's kind of the first basic level of not stopping it, but preventing spread, right? So that's the first thing that we're doing, and we've been obviously very active. The second aspect is how do you deal with it from a public health perspective? Our qPCR instrumentation is used in the CDC specs and a number of other government specs in terms of you use our instruments to run the assays to determine it. So just in the protocols of the CDC are using, that's there. As is our master mixes and amplification capabilities so that you can actually determine the test. So we're very much in there. But as you may have been reading, you actually have to then get the test to be widely disseminated in these types of situations. So we have been working very closely with the FDA. We have given a fabulous assay to them, and they're evaluating it for emergency use authorization, and they go through that process, and it feels like just because of the challenges right now that they're working at a relatively rapid pace. So that's how you go from sort of purely public health to actually the wider spread usage of our testing. Then you get to the research side of the equation, which is our sequences are being used, particularly in China, quite extensively. They monitor how the virus is evolving. And so we've been active there. And then the final one, which may be less intuitive, is that our pharma services business is actually quite active in the vaccine development and production. So we're not the innovator, but actually the footprint to actually produce the vaccine, a couple of the companies are partnering with us to leverage our capability, should they be successful. So we're right in the middle of helping from protecting health care workers to developing the tests and disseminating it widely, to helping with vaccine production.

On the vaccine side, do you think Thermo can play a role in expediting time lines? Normally, that can take, at best, 12 to 18 months?

So we're -- we've made the capacity availability a priority. So it's going to be really the pace on the clinical workforce.

Okay. So from a financial risk perspective, recognizing this isn't just a China challenge anymore. But thinking about China specifically, China represents about 11% of sales for Thermo. And relative to the corporate average, it's actually higher capital than consumables. Within that part of your business, how should we think about the risk, given you didn't capture COVID-19 during initial guidance?

Yes. And Doug, maybe the best way that I can answer to the financial impact, is take a holistic view to it and so how we're thinking about it is -- so the first thing is -- our job is to manage appropriately in the right thing, but it's just the philosophy. Our China business is very slow, right? So you went into the New Year, the Chinese New Year's, and there's obviously been disruption as the economy there has really slowed down. What you're seeing is activity is starting to pick up, but still at a low level. So if I look -- if we look at the runway, we talk to our team. So actually, activity is starting to ramp, but it's at a low level from -- compared to normal. So you start out with the headwind of China is likely going to be weak, very -- in a very short term. So that's the first lens. At the same point in time, because we're aware that this was happening, we have freed up time for our commercial teams around the world, representing the -- effectively the other 89% of the revenue to be superfocused on share gain, driving strong performance. So actually, through the first 2 months of the quarter, ex-China, actually, business is actually pretty decent, right? But remember that those geographies didn't really have any coronavirus impact of any significance to February. So we kind of look at that lens, that's encouraging. Our view is that looking at the likely spread and the likely impact of activity is that our first half revenue is going to be less than what we expected in our original guidance, is the first view on sort of the top line. We believe, but we do -- we're not the oracle on these things, that governments will stimulate and that you'll have some level of tailwind when the virus abates, right? How you compare the tailwind to what the headwind is, very hard to know at this point in time. But certainly, we wouldn't have expected a very stimulative set of economic activities going forward. So if I think about the top line, we know that China is likely to be weak in Q1. We expect that there may be some headwinds elsewhere, and we're taking the actions to maximize our performance. And we could see some bright things, but certainly, we see some headwinds. We have been very cost disciplined in this period. So I think this is where leveraging our experience from going to other more economic-driven things, we have curtailed discretionary spend, doing the things you would do to provide protection on the EPS to its greatest extent possible. So it's very hard to put that all into a number, but I assumed that the first half was weaker than what we expected. We have a path to seeing good news down the road, and our view is that we'll update after we report Q1 about sort of what's our latest thinking, because we'll have the benefit of actually seeing how this trend goes across the world.

That's super helpful and makes a lot of sense. I guess, one last one for me on this. When I think of Thermo, we've gone through this extraordinary period of growth. And some of it's been the market, but a lot of it's been the portfolio evolution that you and the team has led the company through, and it's taking share in part via the portfolio execution and evolution. It's also just strong operational execution. We're now in this period, hopefully, of just a temporary slowdown for Thermo in the broader market. So the top line comments you made, made sense. You made some comments on EPS. And I think by extension, EBITDA. How do you feel about the company's ability to balance? And again, what is a -- hopefully, a temporary period of slow down? The ability to protect earnings targets versus the need and the desire to keep investing in growth? And going back to what you said in your prepared remarks, come out of a period of challenge and uncertainty even stronger as an organization?

Yes, right. And that's -- when we do that well, then that's really what we're setting out to do, right? And if you think about 3 years of very strong financial performance and very strong top line momentum, time is always the constraint that a management team is focused on. It's less resources than where you put your energy, right? And you put less energy on some of the discretionary spend and some other things. So we're not changing our outlook and saying, "hey, we're not investing." We're going to spend more than we spent last year, right? I mean we're investing. But there are certain things you can absolutely slow down without losing your momentum because you basically say, "you know what, there's less opportunity right now at this moment here, let's work on cleaning up some cost side of the equation." So our view, based on what we see today, is we're working on all of those easier levers to pull that makes sense, holding aside sort of the global health side of it. We were curtailing travel, irrespective of sort of the view, not about stopping travel but I would say, "You know what, less internal meetings, more customer-focused, do that. Open positions, everyone needs to be scrutinized." You can go through collapsing types of rules, things are those -- things you do in the normal period of time. And those things don't -- they take effort, but they don't actually slow down your top line growth. So we're not bearish on the world, if you're bearish in the world, there's many levers we can manage through tougher times. If that happens, we know what to do, and we'll do that. But I'm not seeing any signals at this moment that says, "Hey, you need to be more aggressive than the basics at this point."

I'm not sure it's possible. But to the extent that we can talk about China, and I'll talk about COVID-19.

Yes. Yes, sure.

One of the things that you mentioned was -- one area of challenge at the end of the year was high-end instrumentation in this part of the market in China. Again, probably tough to see through COVID-19 right now. But do you think that that was just a timing dynamic? A handful of customers? Or do you think it was an indication of something else that was going on in that market?

Yes. So what we saw in China is our consumable business, which is the bulk of what we do, and the lower to mid-range capital -- it was pretty normal, right, in terms of performance, right? So sort of the basic activity levels, actually was very solid in the very high-end capital equipment, with a few very large specific projects. The funding didn't get released, especially in one case, I personally have known the customer for a long time. It's not -- you didn't lose the business, the customer was equally surprised, right? And why the government didn't release money for some very large capital equipment? I don't know. I don't think anybody has a crisp answer other than to say, maybe it's economics. I don't know what the answer was, but it didn't happen. Our expectation, going into guidance, is that it was going -- it will come back during the course of the year, which is why we said the double-digit growth. But we didn't say it's going to come back in Q1 or Q2, because they were equally surprised that they didn't get the funding either. So in this -- over a 12-month period, it will come back, and that's been our view in terms of it. So it's not the greatest answer, but it's our view of what played out there.

Right. And probably tough to have a better answer at this point, given...

Yes. I mean the capital equipment activity is low because customers are effectively focused on where the -- getting back to work in day-to-day as opposed to longer term planning.

Okay. Let's pivot to the biopharma end market. So biotech and pharma account for almost 40% of total Thermo sales, which is actually up what, 10 to 15 points over the next -- I'm sorry, over the past few years as a percentage of sales, based on acquisitions, some divestitures in other parts of your business and really disproportionate growth in this end market. So Thermo's value proposition is clearly evident in -- this end market is working. What's different about Thermo in this end market versus others? And how do you think about the sustainability?

Yes. So we have methodically built out a very strong position in serving biotech and pharmaceuticals, right? So when you look at our offering, we help our customers accelerate their innovation, which is ultimately the lifeblood of what they do. And we increase their productivity, right? And because we have incredibly unique scale at those relationships relative to anybody else -- actually, if you look at sort of what would be a typical biopharma relationship, both at a smaller company or at a large company, that scale and importance creates a set of access to the decision-makers that is truly unique in the industry, right? And so what happens, as long as we're doing a good job, those success stories create more opportunities to build on your credibility and go forth, right? So if you think about the evolution of the company, right, which is very innovative company with great products and a channel that's doing the day-to-day servicing of their labs in terms of supplying them with everything they need, managing complexity, we've done that very well. We've built out a very large set of contract development and manufacturing capabilities. We've been in the market a long time, but we've been extending it out, and that has really raised our profile even more because we're helping our customers go from idea all the way through developing a molecule, equipping the labs to do that to -- actually doing the development work, helping them through the clinical trials process and managing the physical aspects of clinical trials, all the way through for customers the option to produce with us, second source with us and leverage our expertise both in drug substance and drug product. So we really have built out a very strong competitive position. And we feel that we continue -- we are really accelerating our share gain with that customer base, because when you peel further back the pieces of our business, all are doing extremely well. It's not as if one piece of the value proposition to biotech and pharma is doing really well and the others aren't, and you actually look across the portfolio, you're seeing great strength.

Yes. If I think back over the last decade, I would say, the first half of the decade, and this is a generalization, but I think the way you outperformed your peers in that market was actually gaining wallet share within larger pharma accounts, while others were shrinking. I think it feels like you've continued do that while also participating in some of the growth areas that are more specific to some of the relatively smaller players in the space. Is that a fair high-level characterization?

Yes. I mean certainly, we continue with the largest customers, both in biotech and pharmaceutical, that have very strong relationships and very good momentum. But the uniqueness of our value proposition has put us in a really unique position to serve the emerging companies in terms of relevance. And we have really been honing our commercial model to support those customers extremely well. So yes, I think we have been able to build a bigger set of growth drivers in serving biotech and pharmaceutical through those actions.

How much runway is left on that front from a growth standpoint?

I think it's extremely high in terms of the runway ahead, right? Because effectively, as the customer base is evolving, what they define as core and noncore is changing, which is actually creating more opportunities for us to continue to expand those relationships. So if I take our couple most penetrated customers, they're actually growing really strongly, right? So you say, well, that's sort of counterintuitive, but they're actually generating new ideas as well, right? So I actually am very bullish about the long-term outlook for our position of biotech and pharmaceuticals.

I want to dig in more on bioproduction specifically for a second, but just building off of what we just talked about. What's the opportunity to replicate this biopharma playbook in other end markets? Where are you seeing success doing that? Where is it a little more challenging?

Yes. So when I think about the patterns we -- in for-profit laboratories, we use that playbook as well. So your clinical reference labs, environmental testing labs, where the lab is a business, that's very powerful. Now that only some of the offering is relevant, but that is something that we've been focused on for a long time and see good momentum. There are things within the academic community that you can do, but you do have a little bit of a limitation, which is incredibly decentralized decision-making. So you get some of the benefits of that, but there's also some limits to -- there isn't any centralization really other than sort of framed contracts that drive decision-making. And we're working in the hospital market to do a little bit as well. But pharmaceuticals and biotech strongest, for-profit contract labs next, and then your pockets of opportunity.

Can you do a little more on like the petrochem or industrial cyclical side in a better economy?

You do, and we have focused on that, and we have -- where our offering makes sense. Yes, you do. It's not a huge segment for us to provide opportunity.

Okay. So bioproduction, that business grew, again, very strong double digits in 2019. In years past, you've talked about this as being really a high single-digit growth business. More recently, you bumped that up to your view is that's more of a double-digit business. And I think that's not just your view for this year, but correct me if I'm wrong, the sustainable view?

Yes, it's go a lot of tailwinds.

Yes. So what's changed? I mean you had pretty robust targets already. What's giving you the conviction to bump things up here?

Yes. So when I think about our bioproduction business, what I'm talking about in that lens is our cell culture media, single use technologies, purification, chromatography consumables, basically, when somebody is buying products that they're using for producing their drugs. We also play bioproduction as actually a manufacturer, and we can talk about that as well. But I know you're referring here to that description. And as medicines and pipelines have moved from small molecule to large molecule and new modalities like cell and gene therapy, that tailwind is driving more and more growth in the bioproduction area, particularly for us in both cell culture media and single use technologies, where we're the industry leader, right? So that phenomenon has continued to evolve favorably, and you're seeing more and more medicines going through the process where they're actually getting, as an FDA cleared, FDA approved product, where historically, most of the single-use technologies was actually in clinical product development. Now you're actually getting to commercial scale. So you're seeing a nice tailwind in terms of that, and that's why we feel confident that the growth outlook here is good. It always has some level of choppiness because you get some very large orders, and then you have one quarter that somebody shifts from one to the other. But if I just take kind of an annual view and multiyear view, the double digits feels like the right aspect.

That's a good segue to bioprocessing, where your portfolio consists of many legacy Thermo and Life Tech products, and you've recently augmented that with the addition of BD's advanced bioprocessing product line. Correct me if you disagree, but you guys primarily play more in the upstream segments, or specifically fluid management, fermentation and cell culture media markets here, your exposure to filtration and purification is a little more limited, at least relatively speaking. Is this -- do you have an interest, kind of building off of what you described before and being bigger in downstream capabilities?

Yes. So Doug, when you look at our capabilities, we are -- the vast majority of our activity here is consumables in terms of the plastics and the cell culture media, not a big equipment provider. When I look at upstream, we're very strong. When I look at downstream, we have really good capabilities in purification. So if you look -- and it's a relatively modest-sized business, but if you look at new molecules, one, we're actually doing a good job. So when we're sitting here a number of years from now, that will be a bigger business, because it takes a really long time to -- molecules to go from the early development stage through the process and really build up. But we're very encouraged by that. In terms of the ability to build out additional capabilities, more technology development, meaning that you come up with innovative ideas, then there is sort of an M&A lens to building out the downstream business of any scale.

Okay. Understood. Yes. And the neat thing about what you just described is, over time, that becomes an even more predictable and locked in business.

Right.

Okay. We only have a couple of minutes left. So we'll leave some of the many other biopharma questions we have to the breakout. I just want to close on M&A and capital deployment. So going back to where we started, does the current environment with COVID-19, a slower front end to the year than maybe originally expected? Does that change how you think about capital deployment?

Yes. So when you think about capital deployment, you start with our strategy, right, which is M&A is driven by our capital deployment strategy. Roughly 2/3 of our capital to deploy is going to be targeted towards M&A; about 1/3, return of capital; more buybacks and dividends, but we increased the dividend this year. We've active on buybacks. We've deployed $1.5 billion already in the first quarter. So we were active, right, that's the first one. M&A itself within that. A deal has to strengthen the company strategically, right? It has to be clearly understood by our customers, and it has to be attractive in terms of the return profile. So that's the criteria. And my view is, you look at the world, and we know what the right fits are within the business, and then you look for what's the right time to do transactions. And sometimes, when the market is choppy, that creates opportunities. Sometimes when the markets are choppy, that shuts down opportunities, right? So I don't have a core philosophy of this COVID make it better or worse, just go situationally and figure out what's the right thing on any particular opportunity. No, we're busy looking at things, is this the way I would think about it.

And you're in a great position, right? I mean you have been for a while, but you ended 2019 at a net debt to EBITDA, what, about 2.5x. So with -- I mean mathematically, [ Chris ] and I have looked at your -- the profile of deals you typically would do, look at the cash flow you're generating. I mean you probably, without issuing equity, have $15 billion to $20 billion in capacity. Does that math make sense to you?

Yes, we have substantial capacity. I don't think you go to maximum leverage in the current environment, I think. But we have substantial capacity to do things should the right things to be available.

Okay. And I know we asked this question of you every time we're talking about M&A and capital deployment. Are there any areas of clear priorities prioritization as we sit here today?

The great thing about Thermo Fisher is we don't have to do anything. We have an amazing portfolio, incredibly strong businesses. Each of the sub-businesses are typically #1 or 2 in the markets they serve. They have great outlooks. They're gaining share. The company is gaining share. So there's nothing that we have to do. Everything is in the -- we think it makes sense, we'll do it. And if it doesn't make sense, we won't.

Okay. All right. That was great. We really appreciate you taking the time, as always. I mean we do have a breakout scheduled next door in the Nantucket Suite. Thanks, guys.

Thank you.