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

Good morning, everyone. This is Matt Sykes from Goldman Sachs. Apologies for the technical difficulties here, but I have the pleasure of introducing Marc Casper from Thermo Fisher, the Chairman, President and Chief Executive Officer. Marc, thank you very much for joining us. We appreciate your time today.

Great to be here, Matt. Thanks, thanks for hosting.

Great. Maybe I thought I kind of let you set the stage for us for the first few minutes. And maybe spend some time on what we think is the sort of the key question that we've been receiving from investors. And that's what does Thermo look like in a post-COVID environment? Will it be a faster-growing and higher-margin company post-COVID versus pre-COVID? And how can investors frame their thinking as they try to model out the next few years for Thermo?

Yes. So Matt, yes, it's exciting to be here. It's a good opportunity to talk about the future. And when I think about the company, right, we're incredibly well positioned as an industry leader. And that was true before the pandemic. It's true today, and I'm so confident that it's going to be true in the future. When I think about the question towards how to think about the future, I think let me start with a simple answer, and then I'll get into some more depth. But the simple answer is we'll exit the pandemic a faster-growing and higher-margin company, clearly, than we were pre-pandemic, right? So I'm very excited about the future. And when I think about 2021, and I think looking forward, I think the factors to consider really are around 4 things, right? The outlook for our end markets, the performance of our base business, the recent M&A activities and how to think about the COVID-19 response, right, and the revenue there, that's the 4 factors, right? And I'll do it at a high level, and I'm sure we'll get into more depth on them. But markets look awesome, the end markets are incredibly strong. Pharma and biotech is robust. Academic funding, I think there's so many lessons learned out of the pandemic. The importance of basic research funding, I think it's going to be extremely strong. So we have good end markets. When I think about our base business, we are well positioned to accelerate our share of gain momentum, right? We invested heavily during the pandemic because of the strong financial performance. We increased R&D. We accelerated CapEx. All with the goal of growing faster than the rate that we would normally grow 5% to 7% organically, our base business will exit the pandemic growing faster than that. And we're very confident in those actions. So strong markets, strong base business performance. Very excited about the active M&A that we've been doing. We did a number of small deals early in the year and towards the end of last year. And we announced a large transaction with PPD, which is on track to close towards the end of the year, and that will add $1.40 of accretion with very strong return profiles and strategically a real benefit to the company in the first full year of ownership. So it's very exciting. And then you get to the COVID-19 response, right? And that's always been a lot of discussion these days. In a certain respect -- in a way, it doesn't matter. And it's a fine thing. I've been thinking a lot about it, which is if you think about the COVID-19 response, our customers and governments needed help. We ramped up faster, and we did a better job of supporting that response than any other company in our industry by a long margin, if you look by the level of activity. And we continue to have a very relevant offering. And what we're doing is supporting our customers, we're generating very strong financial performance. That financial performance is on top of the sort of base business performance, but also allowing us to invest more in our business and the free cash flow generation that we have is fueling our M&A strategy, right? So it's temporal. Some things will end shorter than others, like vaccines and therapies likely to be much longer term. Testing will wind down at some point over the next couple of years, and it's been playing out largely as we would expect. But it's kind of the icing on the cake, if you will, on a business with an incredible set of fundamentals. So hopefully, that frames the way we're thinking about the business.

Yes. And that's helpful. I think -- how do we take into account maybe -- you touched a little bit on just the size of the base business, the recovery it's seen and will likely continue to see. And how is the base business growth really going to offset the COVID decline, particularly on the diagnostics side? And how do we think about that?

Yes. I mean, it's not supposed to, right? I mean, the base business is supposed to perform at a very high level. And the COVID response revenue is going to have different levels of duration. And we don't look at it as 1 offsets the other, but rather, we're going to maximize sort of the area of the curve around COVID response revenue and use that money super wisely. And interestingly enough, when I think about how we've performed, there's a tremendous amount of noise around COVID response revenue, right? Some companies -- every company guided in whatever their own assumptions were. Our assumptions have been very clear, right? Which is that Q1's response revenue related to testing would be largely similar to what it was in Q4. That's what happened. And that it would step down in Q2, we stepped down further in Q3, further in Q4 and even further in 2022. That was the assumptions, they're playing out largely that way. Vaccine revenue has actually gone faster because we've been able to scale our manufacturing capacity. We have the demand, but manufacturing capacity is at scale. So that's growing. And likely, we'll grow in 2022 off of the base there. So there will be some puts and takes there, and that's not all going to wash out. I mean, response revenue will be less in 2022, clearly than it was in 2021. But our base business is going to be strong. And the financial performance of the company is going to be quite attractive.

Got it. That's a helpful way to frame it. And how do you believe PPD could ultimately help the long-term growth and market opportunity for Thermo?

Yes. So if you think about PPD, it allows us to add a very logical set of capabilities to Thermo Fisher Scientific, right? It's -- if you think about the strength of our biotech and pharmaceutical offering, the strength of our research tools, our customer channel, our bioproduction and pharma services business, adding the clinical trials, management capabilities, incredibly complementary. And it is a very large, attractive growth subsegment, if you will, in serving pharma biotech. So PPD will add a scale, industry-leading position in a high growth segment, of which we are well positioned to take a great business and grow it faster over time. It's a very complementary transaction. Early customer feedback, exceptionally positive, right? They understand the strategic logic. Our customers are excited about it. Our PPD colleagues are excited to be joining the company later this year, and we think we'll make a real difference for our customers because ultimately, long term, we think there's a really interesting opportunity to shorten the time to bring a scientific idea ultimately to a medicine. That's not something that happens in a year or 2. It takes time. But with the scientific thought leadership that Thermo Fisher Scientific has, we're going to focus on bending that time and cost curve for the pharmaceutical and biotech industry.

Got it. And I think you've talked a lot about the speed and scale, which the COVID response was from Thermo. And one thing I think in all the COVID noise that we talked about, one thing that gets a bit lost is how has this deepened the relationships that you have with your customer base? And maybe there are certain segments or business lines that have really changed significantly as a result of your actions in response to the pandemic, and maybe they've led to deeper relationships and larger relationships over time. Can you talk about that dynamic?

Yes. So entering the pandemic, we had very strong relationships with our customers, right? They appreciated how we collaborate the culture of the company, which is focused on a mission that enables our customer success. It's not about us, it's about actually our customers, is deeply ingrained in the company. But to see how we mobilized and how we supported our customers, whether it was ensuring that in their normal activities of running a biotech company or a pharmaceutical company, that things didn't get disrupted in the pandemic, that their operations or R&D labs stayed up and running. When those companies were focused on COVID-related activities, how we were able to make capacity available, our expertise available to help them. Hugely profound in terms of the credibility that we built on and the new opportunity set that we'll have going forward. And in fact, because demand has been so strong, we accelerated our capital investment programs. Those capital investment programs not only support COVID-related activities, but they're going to pivot to other medicines over time as well, right, in terms of growing our capabilities for those customers. And so it's been fantastic. It's true in the diagnostics side as well, right? We built very strong relationships by helping our customers navigate a challenging time, and it's certainly true from a government relations standpoint. The amount of governments that we worked closely with to help them navigate the pandemic, really has opened up new opportunities for Thermo Fisher Scientific going forward.

Got it. And maybe pivoting towards the diagnostic side. Can we talk a little bit about what you believe the long-term impact of the rapid installed base growth that you've seen this year? And what are the opportunities to monetize that increased installed base? I mean, there's obviously been concerns out there of the spare capacity that investors have on the rapid installed base growth. Some of that will probably be alleviated by older instrument retirements. But with your new installed machines, how relevant will they be? And how can you address that increased installed base growth going forward?

Yes, Matt. Thanks for the question. As I think about our molecular diagnostic offering, right? We had a large installed base around the world going into the pandemic and primarily used for lab-developed tests around the world, where a customer would use our components, if you will, to create the molecular diagnostics for their labs. And we have scaled up and refreshed that entire installed base hugely. So when I think about the transition from the -- certainly in the U.S., but it varies by country, the symptomatic world to monitoring the surveillance, ultimately an endemic phase, that installed base, certainly in the shorter term, the next year or 2 will be used for the winter respiratory panels, right, where you're -- somebody presents with an upper respiratory infection. Is it the flu? Is it RSV? Is it COVID, right? There's going to be clearly a usage in that. There's going to be opportunities around expanding menu over time for those -- for that installed base as well. And we also meaningfully improved our competitive position in sample preparation, used in molecular diagnostics because there was such an acute shortage of sample prep around the world, massive increase in installed base there. That will be used for any types of molecular diagnostic tests. We expanded our capacity and share in specimen collection used for molecular diagnostics. So it's broad-based in terms of the role we play. And clearly, the amount of testing that went on for COVID, there's never been anything like it in the history of molecular diagnostics, right, in terms of the scale. So all of these activities are going to be at a much smaller scale long-term than they are today, but they're going to be much larger than they were coming into the pandemic. So we really exit the endemic phase, whenever that happens, with a much stronger competitive position than we went coming into it. I think that's super cool.

Got it. And also part of that, though, I mean you mentioned endemic phase. Just in terms of longer-term durability for COVID from a diagnostic standpoint, whether it's surveillance or now you have point-of-care with your Mesa asset. How are you thinking about sort of that endemic phase? And now that you have Mesa in the mix, the durability of some COVID testing streams?

Yes. So Mesa, to remind our investors, is a point-of-care PCR test, where you can get a sample to result on-site in 30 minutes with lab-based PCR accuracy. It's actually an exquisite technology. Prior to the pandemic, the company had 510(k) FDA approval for flu and for certain other of the respiratory diseases. And obviously, they've got an EUA for COVID. We have sold thousands and thousands of the instruments, they're called [ docs ] around the U.S. and elsewhere. And that installed base is going to be relevant, right, in terms of high value-added point-of-care molecular diagnostic testing, really interesting opportunity. The way we thought about it is that the COVID economics effectively paid for the acquisition. So it was one of these things where you kind of got an option on all the other interesting things that occur. And then durability, I mean, I kind of referred to it a little bit earlier, but I'd say it maybe a different way. We expect to do, in our last guidance, $7.3 billion of total COVID response-related revenue. And roughly, $1.5 billion of that, Matt, was vaccine and therapy-related, about $5.8 billion testing-related. And that's sort of everything around testing, it's the PPE, all of the different things. We don't want to -- it gets too complicated when you start breaking out all the pieces, right? And when I think about it, we've delivered $2.9 billion of revenue already in the first quarter. We expect to have strong revenue in the second quarter in terms of COVID response and then it wanes during the course of the year. And I was happy that we were able to derisk some of the testing revenue in our last guidance because we were able to effectively increase our vaccine and therapy revenue by $500 million. And it's not that we're more bearish on testing but rather said, you know what, there's more -- a wider range of outcomes on testing than there is on vaccine. So we reduced that component a bit, but we're able to maintain the same assumptions around COVID response revenue and then add Mesa on top. So we'll continue to be super transparent about how it's going, but it's largely going the way we expected it to go.

Got it. And just shifting to the COVID vaccine development work you're doing. And as you mentioned, likely be a longer tail and you have pretty broad exposure. Can you just talk about how this development work has helped inform you on the bioprocessing business and the opportunities in the space and how you expect to grow this business going forward? And maybe also, if you can sort of help us frame the size of the non-COVID bioprocessing business for Thermo?

Yes. So when you think about the bioprocessing, what I'll say is that before you get into COVID and the details, you say, all right, 40% of the company's revenue is serving biotech and pharma, right? And a little more than half of that is bioproduction or bioprocessing and pharma services, right? So on the production and development end of that customer base. So a very scale business and one that's growing very well, right? Effectively, the bioproduction business probably is growing in the -- consistently in that 20% range historically, and pharma services growing in the double-digit type growth. So very strong growing businesses, very good competitive positions. And because of the very robust demand, associated with the pandemic, we were able to massively accelerate our capacity expansions. And they're not only -- it's effectively, I'll call it, generic capacity, a fill finish. When you put a vaccine in final form, it doesn't matter whether it's COVID or another vaccine or a biologic, it's the same technology. And the same thing for our cell culture media expansions or our single use technologies, the application doesn't matter, right? So we've been able to expand it substantially and we've done a good job in terms of supporting the various COVID modalities as well as seeing really interesting growth in supporting other critical medicines. When you think about a couple of examples, our Viral Vector Services was a key enabling technology in one of the recently approved therapies for cancer that just got approved based on our capabilities, a great partnership with one of our clients, life-saving medicines. A terrific inspirational work that's going on together with our customers. And when you read about new drug approvals, we're there, right? Whether it's our fill finish capacity, whether it's our raw materials, we're involved, and it's going extremely well. So we're bullish of that total business this year. We expect about $1.5 billion will be COVID-related activities.

Got it. And just when we look at the overall cell and gene therapy pipeline, and as these therapies move from preclinical to early phase, eventually to commercial development, you talk about probably a greater need, particularly on the upstream side for the different materials that go into it. How do you feel Thermo is positioned for this progression of that cell and gene therapy pipeline to move along and into commercial production eventually?

Yes. So one of the things that -- because of the variety of capacity constraints in the industry that has happened because of demand during the course of the last year or so, we were able to also expand our capabilities, right? So we announced a new plasmid facility in Carlsbad at one of our main centers. And that's exciting, right? In terms of -- it's a new offering for us. It's a very logical extension of our cell and gene therapy offering. So we're well positioned to scale that up. We just announced a couple of weeks ago on the cell therapy side, a collaboration with UCSF, where we're opening up a joint facility with them and that will also work with commercial partners to bring clinical manufacturing and bringing our expertise to cell therapy production, which is super exciting. And we've been expanding, as you know, our gene therapy capabilities, the acquisition of Novasep's European business, the expansion in Plainville, Massachusetts, which is a huge facility. It will be the largest viral vector facility in North America when it comes online next year. These are really exciting opportunities to support the very important scientific breakthroughs that are happening in these areas.

Got it. Maybe shifting to China for a little bit. They're obviously one of the first areas to recover from COVID. You have a strong presence there. Maybe talk about what you're seeing in the competitive dynamic in China from both multinational peers and domestic companies and how you're seeing the trends play out in China currently?

Yes. China represents about 10% of our revenue. So it's about a $3 billion business. And if you take a historical perspective, we performed very well there, right? Over the last decade, averaged 15% organic growth over that 10-year period. As you said, things are largely back to normal. Where we had -- when you looked at our first quarter growth, we had 60% growth in China. But when you strip out the easy comparisons, all of those things when you talk to the team, it's kind of returned back to the normal growth rate. So that's very encouraging. And when I think about our competitive position, and you've heard me say this in the past, we want to make it rational for our customer to prefer to choose Thermo Fisher Scientific. At the end of the day, we want a customer say, actually my best choice and my best interest is to work for Thermo Fisher. And the way we do that is we have all these amazing service and product technologies. But we deliver an incredible experience locally. And that means even localizing things. We announced a joint venture for biologic drug substance. We're producing single-use technologies going in China now for the Chinese market. So these are really great opportunities. And we are performing at a very high level there. So that's our job, and we're very optimistic about our competitive position in China, despite the fact that there's going to be many tensions between China and other countries around the world. And we understand that, and we'll navigate that as effectively as we possibly can.

Got it. Maybe shifting over a little bit more towards -- on the financial side. If we think about business life getting back to normal and looking at sort of the cost savings that have been achieved during COVID and some of them coming back, what things have you learned from maybe the digital engagement side or additional cost savings that you achieved during COVID that you think can remain durable to help boost those margins on a post-COVID basis?

Yes. So Matt, if you think about our normal environment, right? And if you're in that -- in a normal period, you're expanding margins 50 basis points. And you're getting that through pricing, volume leverage and the power of our PPI Business System. That's the sort of the -- if I think back over the last 15 years, right, that's the formula on margin expansion. And what's really interesting is there are really some very valuable lessons from the pandemic, right, which is -- we're all going to travel less. Not zero, right? I was out visiting customers last week, but we're going to travel less, right? And we're going to use technologies to engage with our own teams internally, with customers as well, supplemented by a lot of in-person stuff. So you're going to see savings there. You're clearly going to see more remote-based work and be able to tap into labor pools in places that will give you access to terrific talent, which will drive productivity as well. So I'm excited about the lessons learned in applying them. And I know that our PPI Business System is going to allow us to drive very strong margin expansion long-term and help us navigate the ebbs and flows of the response revenue as some of those activities start to wind down.

Got it. And maybe thinking about on the investment side, you have a very healthy balance sheet. You're obviously in the midst of one acquisition. But how are you thinking about capital allocation currently? And has PPD kind of changed the appetite in the short-term for inorganic investments? Or are you continuing to evaluate the opportunities that are out there?

Yes. So Matt, we've been busy, right? We did a number of small deals, put $1.4 billion to work early in the year, adding to our capabilities. And then announced a $20.9 billion transaction with PPD. And we still have a very busy pipeline and a very strong balance sheet. So we're looking, right? And if the right transactions are available, you'll see us continue to be active, right? We're in the market and for things that would make sense, we'll pursue. And if not, we're totally excited about what PPD is going to bring, and we're really putting our energy around closing the transaction, integrating it successfully and creating lots of shareholder value. And we do that by making sure our customers really see the benefits of our growth strategy.

And then just on the organic side, on R&D. You've done a great job this year of investing in the business. I think in the past you talked about plasma DNA, Viral Vector, both organic and inorganic. How should we think about current kind of R&D levels and organic investment going forward?

Yes. So Matt, here we were able to put extra fuel in the engine for R&D. Obviously, we've always invested at a high level, but we saw some really unique opportunities, and especially as others were cutting back R&D. And you're starting to see already the benefits of it, right? The -- we just launched this week at the American Society of Mass Spectrometry innovation cycle that's happening remotely, just launched a new mass spectrometer, new software suite. I mean it's really exciting about what we're doing. And you're starting to see the early benefits of the elevated investments. And what we're going to do going forward is really straightforward, which is we're going to look at the returns on investment on those investments. And if they look good, then we're going to keep going, right? And if the returns start to normalize down, then we'll be more conservative on those investments. And do like we always do, we'll be good stewards of the company and making sure that we're generating strong returns for our shareholders.

Got it. And as we kind of wrap up here, as we're getting close to being out of time, I look at Thermo, I look at the end markets you talked about, which are so robust. Look at the multiple, and I feel like there's something the market might be missing on Thermo. We obviously have a lot of the COVID noise going about that we talked about earlier. But what do you feel is most -- still most misunderstood about the current situation with Thermo and what the market might be missing?

Yes. Matt, it's a great question to close on and I appreciate it, right. My take is, I think investors are confused by the COVID revenue response story. I think there's confusion there. And the way that I think about it is, if you look at our P/E ratio as a company, and you look at the forward P/E on January 1, 2020, right, and you say, right before the pandemic hit. And you look at it today, right? The S&P's P/E ratio, the [ 4P ] has expanded. A number of the life science tools companies have expanded PE multiples. Ours is actually contracted during -- if you look at sort of from the beginning of 2020 to sort of June of 2021 at this point looking forward. And I think that's related to investors not understanding how to think about COVID response revenue. And from my own perspective, having been here for 20 years, the COVID response revenue was not actually the story, right? The COVID response revenue has been added fuel to an amazing growth strategy, extra horsepower, if you will, to drive it and create shareholder value. We're going to do a great job of maximizing that, doing a great job for our customers and also effectively winding it down as it does. But with long-lasting is a faster-growing business, serving really strong end markets with extremely energized customers and employees, and that combination is going to be awesome, and I couldn't be more excited about what the future holds with Thermo Fisher Scientific.

Great. Well, with that, Marc, thank you very much for joining. We really appreciate your time.

Very welcome. Have a good day.

You, too.