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

Thank you. Good morning, everyone. This is Derik De Bruin, the senior life sciences and diagnostics tools analyst for Bank of America. With me is my colleague, Juan Avendano. Welcome to the second day of Bank of America's 2021 Virtual Viva Las Vegas Health Care Conference. Kicking off our next presentation, it's always a pleasure to welcome Thermo Fisher Scientific and Thermo's Chairman, President and CEO, Marc Casper. Marc, always good to see you. Sorry, we're not in person in the Encore this year, but I hope you're doing well, and thank you for being here.

Derik, thanks, and Juan, thanks to both of you for having me. It's great to be able to participate in our annual May get together. Virtually or not, it's still a terrific opportunity.

Yes. So Marc, I -- to set the stage, would you like to do a few opening remarks? I'm probably going to need that because I actually found it rather hard to prepare for this presentation because it's been a rather quiet year for Thermo with not much going on. So I need all the help I can get.

Yes. So I think that -- let's cover -- I'll try to frame it in a few different ways. First of all, I always value the fireside chat. And what I think about today, just try to be helpful from an investor perspective, is try to step back a little bit, right, and talk about the company from what were we like entering the pandemic? What has the pandemic allow for us to focus on and accomplish? And how does that position us for the future, right? I think that's always good because sometimes we get [ so caught ] in the moment that you lose a little bit of the sight of it. And obviously, there'll be, I think, a great opportunity to discuss things around the strength of our end market, the strength of our pace business, the longevity of the COVID response activities and what does capital deployment look like for the future. And I think if we cover those topics, we'll give our investors a real sense of it. So that's, obviously, [ hopeful ]. And Derik, if you want, you want me to chat a little bit about the question that you've asked me a lot this year already, which is '22 and how am I thinking about it? Or what would be helpful?

Well, I mean, I was going to start off with my usual question of what's misunderstood given the company had such strong results. And I mean look, you've outlined the core business, you've added a big deal. And yet people are still worried about '22. I mean so I was going to use the what's misunderstood and then segue to so what can you tell us about '22 and longer term. So yes, I was going to ask you that question.

And I like it. And we go back and forth because we've known each other for 2 decades, so it's a good thing. So I'll try to weave into what's misunderstood and a little bit about '22 into one kind of comprehensive discussion, if you will. I think actually, the best way to start to think about next year is actually to think about what 2019 exited at, and I'll explain why for a second, right? So we entered 2020, seems a long time ago, as a $26 billion company. We grew organically 6%. We had operating margins of 23.5%. We earned $12.35 a share, right? So that was the starting point. Well-respected industry leader, fantastic history, going from the last 10-plus years back. And the world would have expected Thermo Fisher to grow 5% to 7% organically last year, [Technical Difficulty] basis points margin expansion and low teens EPS, right? So that was the context. Obviously, last year was a special year, right? 25% organic growth. We took margins from 23.5% to about 30%. We grew EPS 58%. And as we start this year, right, when we raised our guidance recently, we're expecting this year to have 8% organic growth and we're going to have stable margins at around 30% and EPS growth of 12%, right? So the last couple of years, we're at a much higher revenue base certainly than we entered the pandemic and at a very strong growth in earnings and very high margins. So that's the starting point, right? And then I think about -- and because of that huge change over a short period of time, it's confusing, right, to how to think about the future of the company. So I get it. And so what do I think about the future? What do I think is a little bit misunderstood? I think the way I would frame it is you have a number of dynamics going on in the base business. You certainly have an interesting set of discussions around the duration of the COVID response. And then what are we doing from a capital deployment perspective. From the base business, I think the thing that's most misunderstood or not quite appreciated would be the [Technical Difficulty]. Because of the very strong performance in 2020 and the continuation of that performance certainly in Q1, we've been investing very heavily at a above normal rate in the base business because we see great opportunities to accelerate share gains going forward and drive great returns, right? So if you think about what we're doing is we're taking a business that historically we've been a 5% to 7% organic grower and exit this period a faster-growing business, right, just in terms of base organic growth. And it's [ not ] the same magnitude, right, in terms of the capital investments, the R&D increases. Greater than 20% increase in R&D, it's meaningful, right? And so you have that fueling of the base business and coming out of the pandemic, a much faster-growing company, I think that's super exciting. I think the other aspect of the base business that may not be really fully understood by investors is the long-term outlook for life science tools, diagnostics and pharma services infrastructure, if you will, should be faster growing than the historical 3% to 5% market growth, right? If you think about what's going on in the science, what's going on [Technical Difficulty], I think actually, the fundamental market growth should be better than the last few years. And that means that organically, this base business of this company going forward should be very strong for a period of time. So that's just to clarify that view, and I'm excited about that. COVID response is a really interesting question, right, [ with ] how do you think about the longevity of it? And you have different companies saying all different things about their own views of it. And the truth is nobody knows what the longevity of the COVID response is. People are making assumptions, but we don't know how the pandemic is exactly going to play out. And will it follow the pandemic of 2019, '18 and it's sort of a couple of years' cycle and it's gone? Or is this because of the interconnectivity of the world and variants, is it longer in nature? And there's many different scenarios. So what I can tell you is what are we assuming, right? But I can't tell you that I'm right, and I wouldn't pretend to be, right? Our belief on COVID response, which has been extraordinary in terms of the magnitude, having the largest COVID-response revenue certainly to the 5 quarters of where COVID response revenue was generated last year and the first quarter this year is that vaccines and therapies are going to be relevant, at least in through '22, maybe longer, and likely for us to build from the '21 level of $1.5 billion, right? So if I say -- if I think about the vaccine and therapy piece, we think that has a longer run to it just because of the nature of how widespread the disease is. Testing, we've always believed is temporary or temporal, right, which is you would expect it to get down to an endemic phase and somebody presents with a respiratory symptoms. And whether you're testing for the flu or COVID or RSV or whatever different disease [ testing ] panels to confirm that [ perhaps ] COVID as part of it, but there is a huge bubble in the middle of which we played a big role. And we expect it to continue to temper down during the course of this year. Nothing has changed in that assumption, right? We assume that Q1 was going to be higher than Q2 and continue to moderate down. And there will still be testing in '22, but at a further reduced level from the second half of this year. That's the assumption we're making. The one wildcard in all of that is really about surveillance testing, right? The U.S. is funded but not really enacted very large surveillance programs to support K-8 schools. And we're playing a role there, and obviously, some of that's embedded in our outlook for the year. But if surveillance testing remains widespread, then obviously, there's going to be longevity on low-cost PCR test, and we're well positioned to serve that. And then the final aspect of '22 is going to be M&A, right? The deals that we've completed and the strong balance sheet that we have. If you look back to 2019 when we had our analyst meeting in May, we've actually deployed almost exactly the amount of capital that we said we were going to deploy over the 3-year period, including PPD, right? So PPD will add $1.40 to our earnings in the first 12 months. We've done a number of other transactions. We're continuing to have a busy pipeline. So we believe we have a strong outlook next year from a earnings driven, [ from the ] capital deployment activity. So those are the variables. It doesn't give you a specific number, but I think it gives you the pieces of the assumptions that you can make to [ calculate ] a range of outcomes for next year. So hopefully, that frames it, and you can start follow-up question wherever you'd like to go.

Yes. I mean, just sort of listening, I think the first one I've got from investors is more so on the base business margin structure. Excluding COVID, how has the underlying core margin of the business improved since 2019?

Yes. So it's hard to do it exactly that way, right? We're up [ still ] about 6 points from 2019. The reason I say that is we dramatically accelerated investments in mass spectrometry or electron microscopy because of the COVID earnings, right? So there isn't a pure play, right, of doing it because it's not the way we manage through it. The way I would say it is the base business and the mix of business we have should be generating in the normal [ pre-COVID ] periods of [Technical Difficulty] of margin expansion, right? You're going to see some decremental margin pressures as you see testing response revenue come down. There'll be some pressure on margins there. But for the full year, we're expecting margins to be relatively constant to what we saw last year. And I would expect that as testing becomes more temporal, that's going to be at a little higher margin than the pharma services activity that is likely to be longer lasting. So that's how I would think about it.

Got it. Got it. Just staying on the topic of diagnostics. I mean you've done this massive expansion of your real-time PCR fleet during the pandemic. I mean how do you think these instruments are going to be used as the pandemic wanes? We've talked to some of the labs that are definitely going to get -- basically, they're going to use Thermo's machines because they're going to move stuff over to it. I think some other labs are talking about maybe mothballing equipment. So how do you see sort of thinking how your overall diagnostic experience evolves? Because between that and Mesa, you've got a different business you had going into the pandemic.

Yes. And Derik, if you think about one of the things that -- we have an enormous installed base pre-pandemic of PCR instruments across all the public health labs, all of the research labs within academic medical centers and a very large installed base and primarily used for lab-developed tests. And that was the -- so it's kind of a buy components from us [ and ] customers who had developed their test. And it was a nice business, a niche player in molecular diagnostics, right? And if you think about the leadership that we had in fighting the pandemic, right, what does that really mean in reality going forward? The installed base is refreshed and expanded, right? So which means that the longevity and value of that installed base is clearly much better than it was coming into the pandemic. And we've enhanced our reputation hugely. So you're going to have customers that have really relied on us will move more lab-developed tests onto that -- those platforms. Not every single customer, but clearly, you'll see more activity than you had coming into the pandemic. The areas that are super interesting, we're going to add content, right? We'll add panels and regulated panels for COVID and respiratory. So it makes it customers can choose between buying the regulated product or doing it themselves. And there're pros and cons for them to do that, and they'll make their own decision, but they have that flexibility. But when you think about what has really changed is our sample prep position has changed hugely, right, which is we had a nice sample prep position, and that installed base has been hugely expanded. And so that will continue to be used going forward. So that's very exciting. And then obviously, we've added things like specimen collection, where we were a couple [ of ] share player, literally, and we will be one of the largest players, and that will continue, right? So we'll have a larger business than we had coming into the pandemic. We have happy customers, and that's how it will migrate down. Mesa will be an interesting addition, right, where effectively COVID activity will pay for that acquisition. And you'll have a large installed base of those docs that can be applied to other molecular diagnostics in a rapid, easy-to-use pharma care setting. So I'm excited about what the prospects are for the diagnostic business, albeit that will not be the biggest impact post-pandemic. Actually, the investments in the company and the acceleration of the entire base business is really where you're going to see the biggest benefits going forward.

Right. I mean sort of thinking about it, I mean, the sample prep gain, the specimen collection gains, Mesa, I mean, I would almost argue that's a lingering-COVID tailwind, right? To go -- I mean, that was business that wasn't there pre-COVID, right?

Sure.

And so as I -- and that's sort of how we've built our model as we thought, yes, we know bioprocess is going to go. We know there's going to be some residual testing. But you're going to -- but Thermo is also going to get this massive contribution from these other share gains in the space and the expansion that wasn't there. So when I sort of think about the COVID-related revenues, I sort of lump all of this into the bucket. But on top of that, I also agree that the core business should be going better just because of the massive investment you're seeing around the world in science on this. So let's bounce over to that for a bit and let's talk about some of the academic and government spending that's going on and some of the push there. And I go, how does this funding trickle down to Thermo? And what does it mean for your overall outlook? Because I mean, clearly, you've got a much bigger exposure to that particular R&D end market than most of your peers.

Yes. So we're excited. If you think about -- when I talked historically about 3% to 5% organic growth in the markets, what's embedded in that, Derik, as you know, is 2% to 3% growth in academic and government, right? That's sort of the long-term historical embedded in that 3% to 5% with pharma and biotech being a little faster and industrial and applied, cyclical, but a little faster, and that's how you get the 3% to 5%. It feels to me that the academic and government end markets are going to be quite strong for quite some time, right? The interest in science funding, the NIH as a U.S. example. The U.K. has huge initiatives to ensure the future of the life sciences industry. You're seeing the EU programs. And obviously, China is trying to -- as they build a more independent economy are fueling significant investments in the academic end markets. I think that bodes very well, and we're very exposed there, right? We serve every lab. We do all of the lab consumables, the instrumentation, the basic lab equipment, all of those things to fuel academic and government. We have a leading position there, and we're excited about the prospects.

And in general, that's a much higher-margin business than your pharma business just because academics don't have as much pricing power or [indiscernible]?

You have a more [ diverse ] customer base, for sure, right? So yes.

Yes. So yes, I mean, is there -- I mean, we've always been trying to ask this rule of thumb, for every 1% the NIH goes up, what it drops down to Thermo, but I haven't been able to successfully do that. It's particularly impossible now given the mix of business [ level the NIH is at ]. But speaking of the mix of business, let's talk a little bit about bioprocessing. The market is booming, not only for vaccines, but also for cell and gene therapy. You just mentioned you were at a viral vector opening [ or reopening ]. Can you talk about where you're investing in bioprocess [ and ] capacity expansions? And I guess one of the bigger questions I get from investors is what can Thermo do to build their downstream bioprocessing footprint or do you need to?

So Derik, it's a great question. So I think context is always helpful. Today, about 40% of our revenue serves pharma and biotech. It'll be closer to 50% of our revenue from [indiscernible] as we close PPD. Within that 40%, more than half of that revenue is our bioproduction and pharma services activities, right? So that's the first contextual standpoint. When I think about the -- what's going on within it, we play in 2 different aspects. We have a roughly $2.5 billion biosciences and bioproduction set of offerings that are used in that part of the manufacturing and development process. I'm excluding all of the research aspects of bioscience, right?

Correct.

So all of your enzymes and nucleotides that are used in manufacturing all of the purification resins, single-use technology, cell culture media, that's about $2.5 billion. You have roughly a $5 billion pharma services set of capabilities as well, covering the full range of drug substance, drug products for small molecule, large molecule, viral vector, monoclonal antibodies, et cetera. So a very comprehensive offering, rapid-growth business. The pharma services growth business is roughly a 10% plus business. The bioproduction, historically, is a 20% plus growth business, growing much faster than that right now. But -- so super attractive positions. And when I think [indiscernible], nothing should be have to have. You don't have to have -- we don't have to have filtration if it's not a requirement. It's something you could add, but it's not something that per se we are adding. Purification, we actually have a nice niche position that's growing very rapidly. We're well positioned to serve mRNA from a purification perspective, and that's doing very well. So we're excited about how that business is going. So when I think about it, we've invested substantially in our CapEx programs to pull forward future expansion so we can really grow this business and sustain it for quite a number of years. And what's exciting is COVID has effectively paid for those expansions, and the capacity is easily repurposable to other therapy classes over time. So it's one of those things where, in a way, the pandemic fuels the [indiscernible], and you get the return not only on COVID, but you get the return for oncology and other [ diseases ] over time. So that would be my first pass as an answer to the question.

Got it. And so how should we think about [ owned ] period of CapEx investments going to continue through this? So is this -- because maybe this boils down to a free cash flow question and thinking about what -- this is a more capital-heavy business than your Life Technologies business.

Yes, it is. So I think it depends, right? So -- and I'm not giving you a waffling answer. If you think about the programs that we've initiated, they'll largely be complete in '22, right? Meaning that you have the scenario, you finish the various expansions that you're executing on or we're executing upon, that gives you the capacity that's coming online even now and continues to. And you start looking at your funnel of activities probably at the beginning of '22 and say, how successful were we in filling up the plants with new book of business that we have secured. And you know then whether you want to continue to be at an elevated rate because you're going to get spectacular returns. Or you say, you know what, I'm going to use the next couple of years to absorb the capacity that we've invested in, and therefore, you're allowed to bring down your CapEx for a period of time. So I actually don't know what scenario it is. My instinct based on how strong demand looks right now is that you're going to wind up being elevated maybe even for '23 just because there's such a strong demand profile. But we'll only do it if it's sort of in the no-brainer in that you're going to get great returns from the heightened investment.

So a couple of client questions. On the margins for the vaccine business versus the base, is that a higher-margin business than the overall core business?

Not really. I mean it's pretty -- the vaccine margins are pretty similar to the other pharma services activities that we would have. So it's not a real difference there.

So I've got 2 investor questions here on your capacity for additional M&A. So how should we think about deals? Basically, if you're integrating PPD, does that preclude you from doing a transaction in another segment of the market? Just how do you see sort of capital deployment beyond PPD? Because you know what they say, it's what have you done for me lately? Yes, you haven't closed PPD yet, but what's next?

Yes. So Derik, a couple of things. One is I'm super excited about PPD because our customers see the benefit of us having a leadership position in the contract research space, right? And that it will be valued, and that will allow us to take a great business with a great team and further accelerate the outlook for that business and the whole company. So that's super exciting. It is an additive business to our capabilities. So while there is integration work to be done, we have both the financial and management capacity to continue to be active in this period of time, right? So our pipeline is busy. We've announced a number of smaller bolt-on transactions, and I think you'll see us continue to be very active. And we have a lot of financial firepower. So if there's the right thing out there, you'll see us do it. And if there's not, you'll see us continue to be very disciplined and wait until we see the right opportunities out there. So that's -- I think you'll see us be very active if there's the right transaction.

And Marc, so I'm going to circle back on diagnostics to a certain extent, but also just on your genomics business. I'm just sort of wondering what -- you've done more investments in things like Ion Torrent, now you've got the Genexus platform. You clearly have a massive portfolio of tools. You're the best company positioned in the multi-omics space. How do you sort of see that like genomics market, sequencing, liquid biopsy, that whole area of companion diagnostics, how does that sort of move forward for Thermo?

Yes. So our genetic analysis business has obviously performed incredibly well because of the role it's played in the pandemic. But our next-gen sequencing business has been growing quite strongly actually, but we don't talk about as much because it's smaller than the qPCR franchises given the role it's played in the pandemic. But we continue to bring out the new instrument capabilities, that's been well adopted. So our Ion Torrent platform is doing well. A lot of our clients are using it for liquid biopsy, right, because it's -- they don't view us as competitive with their efforts. And we're continuing to add new assays to it as well. So I'm excited about what our clinical sequencing business' outlook is. It's a strong grower. It's a #2 position in the market. And in our niche, we're quite relevant and very complementary to our full suite of PCR, microarray, sequencing technologies.

Yes. So I would be -- get yelled at if I didn't ask you the other major question I always get from investors, particularly right now, tax rate. Thermo has a low tax rate. A lot of talk going on in Washington. Is it sustainable? How do you sort of think about where the tax rate goes?

Yes. So as you know, historically, we've done a very good job of being very effective at managing our tax rates over the years. And we've done that in periods of time when countries have made meaningful changes to their tax policies, right, and we've navigated that effectively. And we're staying very close to what's going on in the U.S. and what's going on outside the U.S., and we believe that we will exit this period with a competitive advantage. What that exact rate is going to be? I don't know. We'll see how it goes. But do I think we will navigate that super effectively? Yes, I do. So as we know more about which policy [ they're ] putting in place, we'll be very transparent about what the impacts are for us.

Got it. So we've been getting -- Thermo, obviously, a big investment for a number of investors that are in the ESG area. So I'm going to close with an ESG-related question, sort of thinking about how does sort of Thermo look at ESG? What do you think -- so when we're looking at the life sciences industry, in general and Thermo in particular, what do you think is the best criteria for -- to evaluate Thermo on an ESG basis?

Yes. I mean if you think about our mission first, right, enabling our customers to make the world healthier, cleaner, safer, I mean that is ESG in the essence. But how we run the company is totally consistent with that, right? And the measures, are we a good steward, right? We give back to our communities. If you think about what we did last year in terms of mobilizing to support the black minority communities in the U.S. So making testing available and donating to that at the educational institutions. Or you think about what we're doing in India today, where we have a $10 million philanthropic effort to help the government provide a safe environment for their people. We mobilize to make a difference, and I think that's a big part of what ESG is.

Great. Marc, we're at the bottom of the hour. And thank you again always for an exciting conversation. I'll make the shameless [indiscernible], please vote early and often. We appreciate it. Marc, thank you for being here. Thank you, investors, for listening. And have a great day, everybody.

You too, Derik. Thank you.

Thank you, Marc.