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

Diagnostic sector here at Morgan Stanley. I'm delighted to have Thermo Fisher here with us today this morning, and representing the company is Marc Casper, President and CEO. Before I kick things off with a Q&A, I need to read a little disclaimer. Please note that the webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This is not for members of the press. And if you are with the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep.

So with that, Marc, welcome to my first Morgan Stanley conference. I'm delighted to have you with us. Perhaps just to set the stage, TMO has come a long way over the past decade. Could you just walk us through the evolution of the company during your tenure as CEO? And as you look at that journey, what do you think makes Thermo more resilient and versatile today than it was back in 2008?

So thanks for having us today, and good morning. So when I look back at the company over the last couple of decades since I've been with the company, we've been executing a similar strategy for that period before I was CEO through the period of the last decade and this decade, where I've been CEO. And that's really leveraging our scale to have a differential position, right? Take the advantages of our size to have -- be more efficient in some areas and be able to out invest others in areas that are highly valuable, commercial infrastructure, research and development, things of that sort, that really create a flywheel effect for the company. But the thing that -- if I really look at the journey the company has been on, it’s all been about creating value for our customers, enabling them to do the important work that they do. And ultimately, by doing that every day and focusing on their success, it creates new opportunities for the company. And if I think about how we've grown and how well positioned we were coming into the pandemic, enable us to site a response, that's the work that was done a decade earlier, right? Just the team focusing on helping customers, helping governments. And when people were in a pinch, they came to us. And that really is how I think about it. Exposure has changed a lot within the company, right? If I think back over kind of in the pre -- the last recession, right, at the end of the previous decade, we were much more industrially exposed. We had 15 points more of industrial exposure today. That's really all now in pharma and biotech. Over 40% of our revenue is serving pharma and biotech. We're much more recurring in nature, about 10 points less instrumentation. Now we're moving more towards consumables and services. And geographically, we're much more of a balanced view with about half of our revenue, about 13 points less than the last decade in North America, and that really has been primarily gone to Asia Pacific. So both in terms of -- companies evolve from a kind of execution standpoint, but also our mix has changed. We've been able to accelerate growth in many parts of the company.

Got it. And then touching on that point you made about your COVID-19 response. I mean, it's been phenomenal to see, I mean, both in terms of its scale and its speed. As you look at the COVID sort of testing opportunity specifically and we look to return to normalcy, perhaps have schools reopen, go back to the office, where do you see a role for all the different testing modalities that have emerged? I mean there's PCR, NGS, serology, now some of the antigen tests from Abbott and Roche as well. And has your thinking evolved at all on the testing opportunity for Thermo over the last 3 months or so?

Yes. I think the -- on the one hand, it's very fluid and things evolve. On the other hand, it's actually incredibly consistent. So it's how are those 2 things true at the same time, right, which is, if you think about it, customers want to know with a high degree of accuracy whether somebody has the virus at this moment in time, right? So that's PCR testing. That's also antigen testing. The difference there between the 2 is that PCR continues to be the gold standard, right? It is extremely accurate. So if it's giving a positive result, you have a very high degree of confidence. It's the same thing on the negative results. So PCR testing was first in terms of availability. And we, in particular, were able to scale up our production in a very dramatic way so that we're on track now to be able to produce 20 million tests a week, right, volume. And because our platforms are available around the world, right, there's over 25,000 of our qPCR systems around the world, customers were familiar with them and comfortable, and we really have been the company that's been able to scale up seamlessly, staying ahead of the volume demands of our customers, right? So as new modalities have come out, antigen testing becoming more widely available starting now, that opens up new use cases around back to life, right, as opposed to sort of the medical side of where a lot of the testing was done. And so what we see is actually a bright future for PCR, complemented by other technologies. If you get a positive with an antigen test, you're often going to reflex, right, to a PCR test to validate. We see the demand picture strong. And I look at, at least from a financial perspective, as we entered Q3 at the end of July, we expected to have about $1.1 billion of all of our COVID response revenue. And when we had our Analyst Day last week, which actually for this quarter is $1.6 billion on what we would expect for the full year about $4.5 billion of COVID response revenue. That's just primarily our testing, our sample prep, those things are associated with it. We also have some other activities which bodes well for the future. But we see PCR being an important component of testing for the foreseeable future.

Got it. And then just given the breadth of your portfolio and your global presence, Marc, I mean, you're -- in a sense, you're in a unique seat to be able to have a pulse on a potential second wave or a pickup in disruptions because of the pandemic come fall or winter. How do you think about that? I mean, are you seeing any early signs of that in certain regions of the world? And perhaps, I mean, do you expect that the second wave would be more muted because we've gone through this once, we understand what we can and cannot do and what our limitations are?

Right. Yes. So I think the way we view it is the virus has been present, right, throughout, right? So it's less right now about a second wave than you have hotspots, effectively where people stop socially distancing, those kinds of things, parties have -- wherever it is, you see hotspots emerge. And that's happening in many countries around the world. And for a period of time, you see a level of discipline and control, and then you see it spike up. So right now, we're still kind of in that phase that we saw earlier on. But what's very different today is the medical community understands the virus better, so outcome is better. Even without a lot of different medicines are available, just understanding what works and what doesn't work from a response is there. PPE is widely available, and testing is widely available, right? So it's a very different situation. When I look to the future, customers want to have the option of telling whether somebody has the flu or not, right? You have a lot of multiplexing that we're launching and others are launching to be able to determine what is that respiratory illness that you have because you're going to have a different response if you have the flu versus COVID, right, in terms of the concern. So we expect that. And we're seeing customers prepare for even on a testing standpoint. What we're seeing is instrumentation demand is strong, customers putting in, what I'd say, kind of blanket orders, so they're not taking shipment right now, but they're basically [indiscernible] we're expecting to need product into the fall and into the winter. So I think the world is expecting for the virus to be around, whether it's a second spike or not, I don't know, but that the world is planning for it, and therefore, we think testing is relevant. And obviously, huge amounts of activity on the therapy and vaccine side of which we're also very engaged in.

Got it. And then going back to your response, Marc, I mean, at the Analyst Day, you did sort of mention in passing that the PPI efforts in -- that are so central to Thermo's culture played an important role. Can you make that a little bit more concrete for us in terms of how exactly -- perhaps it was the scaling of the VTM production? Or was it the speed of developing the COVID test and rolling it out and now ramping it up? Where exactly did PPI sort of like fit into the equation to enable that response?

Yes. So practical process improvement business system really has every colleague incredibly ingrained with them is that when we come to work, it's our job to find a better way every day, right? And we're looking for ways to improve the company. And you see that in a long journey of performance, whether it's financial or market share gains. It's really about if you're creating a better experience for your customers, that's very well ingrained. So the pandemic happens, right? And it actually -- things seem to move so quickly. But it really started out with demand in China was going to be soft. It was a China-related issue. It wasn't a global issue. So actually, the discipline around PPI originally was, all right, we have a cost challenge because we know revenue is going to be soft. And therefore, let's pull the productivity levers harder, right? So the team around the world said, all right, China has contributed great growth for many years, and now the other 85% of our revenue we're going to focus on being as efficient as we possibly can so that we deliver good results in a more muted growth environment. So the first aspect was around cost. That quickly -- period ended very quickly as it became a societal response challenge, right? And by mid-February, that was clear to offset. It was no longer a sort of China growth challenge. And the scaling up of our production, right, is pretty remarkable to see you read a lot in every popular press about sort of supply chain issues. But if I think about the number of customers that we were able to gain, the relationships that we strengthened already had a good foundation because we didn't disrupt our customer base, that we were able to produce millions of tests that we get on schedule, right? When I was at the White House in March, I talked about we would be able to get to 5 million kits a week. And then when I was there in April, it was 10 million, and we met those objectives, and we're now doing 20 million. That's all about the discipline of PPI. Now the interesting thing is that in an area that we were a tiny participant, which is a specimen collection for virus, we had a very small product line around viral transport media. When the government put out a bid basically saying we need to get that a lot more production, we won that bid, and we didn't even have a factory that was scalable at that moment to do it, right? In 6 weeks' time, from the kickoff to launch, we're now producing 8 million tubes a week of viral transport media, and huge impact on society from a positive way. And that's PPI, right? Turning that constant focus on doing things well and effectively, taking a project that probably would have been a year in the old world of sort of the time line for a capital project to basically saying, society can't wait, how do you do this in 6 weeks and having local officials do the approvals having contractors be ready. All of that work 24/7, safely doing it, that's all about our business system and the resiliency that we have.

Got it. And then just looking ahead a little bit, Marc, I mean, how should investors view the durability of these tailwinds heading into sort of 2022? I mean, obviously, there's testing in place now, it's going to slowly possibly ramp down next year, but VTM production is ramping, and you're replicating your efforts in Europe as well. And then there's the big sort of giant in the room around sort of therapeutics and vaccines and how you participate in that. But is there a scenario where there could be a little bit of an air pocket in the model in terms of your COVID tailwind?

Yes. So it is a great question, right? And if I think about I've been thinking. There was a question we had last week, just generally as well. It's an important question about how do we see the future with granularity in a world that's hard to do with that. So the way that we think about it as follows, right? If I think about our testing ecosystem, right? It's going to be relevant for a while. So there's going to be meaningful revenue in '21. And depending on how widespread the virus is, where we are on vaccines and therapies, there's going to be a range of outcomes than what it's going to be. But we see that being meaningful, right? When I think about the 250, the scale of that, 250 projects on therapies and vaccines that we are participating in, through our bioproduction and cell culture media, the single-use technologies, the purification resins, all the way through our CDMO business capabilities, sterile fill/finish, active pharmaceutical ingredients, biologic drug substance, all of those different projects, it's 250 projects, what we expect is about $1 billion of revenue from what we have contracted today. That's actually not assuming some giant success with any of those projects. But if those products get into the regulatory process where they're approved, obviously, you're going to get additional demand there. So you see those dynamics to when that happens, hard to know. But I think the thing that I think is sometimes a little bit harder to capture right away is the long-term benefits of the actions that we've taken today or sort of -- you have all the direct COVID response revenue at some point, right? There'll be -- we're not going to be talking about COVID anymore, right? It may be a while from now. But at some point, there'll be a memory. But if you think about the terminal value, it's not just the direct revenue, right? We expanded our sterile fill/finish network, right? That capacity is going to be used for other drugs, right? And that's going to replace that COVID response revenue at some point. If you think about the expansions we've done in our viral production, right, and the new customers that we won that annuity is going to continue, even if the products are no longer used because effectively, you've done a good job supporting your customers, they're going to bring more business to you, right? And you go through the list, we've expanded our plastics capabilities. We've invested aggressively in R&D in this period. All of those things create a replacement revenue because the company was able to reinvest that COVID dividend, if you will, is [ keeping ] a brighter future for the company. So I'm very bullish about this period not only has created a very large revenue specifically around COVID, but that actually accelerates our long-term growth because we've done a good job for our customers. We've done a good job for governments. So all of those things create a really positive momentum for the long term.

Got it. And then, Marc, I mean, as we think about the different vaccine modalities there, you've sort of spoken about how Thermo is essentially agnostic to what ends up winning the race or if it's multiple different candidates that end up winning the race, but in terms of your Patheon standing to benefit from the upside. I mean, is there a meaningful difference across those modalities, I mean, obviously, versus the other?

Yes. And when I think about the economics of the various vaccines that are in development, we have different share positions in the different companies and the different modalities. So you have the generic, which ones are more life science tools-intensive. And it's probably not that much -- probably the live virus one might be the most intensive, if you will, in terms of it. But if I think about it, they all use our industry's capabilities pretty aggressively. And then it's about what your relative share within them. So we participate in so many different projects. Some of them are going to generate more revenue for us so they have the successful candidate, some less, but I like the role we're playing across that portfolio of therapies and vaccines that are in development right now.

Got it. And then how do you think about the ex U.S. or perhaps even the ex Europe opportunity on the vaccine front for Thermo? I mean there's a little bit of -- there's geopolitical overlay to this with countries wanting to have domestic production, but at some point, I mean, the scale is so immense that people will leverage manufacturing even if it's in a different geography, if there is excess capacity there. So how do you envision Patheon sort of fitting into that scenario?

Yes. So if you think about our network today on the pharma services side, it's largely U.S. and Western Europe. So when you think about, let's say, sterile fill/finish, we have large facilities in Western Europe and the U.K. in addition to the U.S., right? So we're -- with the global companies, we're often going to be doing activities in both continents, right? So that -- and it varies by company. So you'll see us play that role. When you think about our bioproduction business, where we're doing the -- effectively the raw materials or what's used in that product itself, that's a very global business. We have a large role in some of the Chinese products as well for that local market, right? So because in almost every country, we're the largest domestic company. Even though we're multinational, we're the largest company in the local market, and therefore, we have a role throughout the world, and that's how we see it playing it.