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

Good morning, everyone. I'm Derik De Bruin, the senior life sciences and diagnostics tools analyst, and joining my colleague, Mike Ryskin. Welcome to Bank of America's 2022 Healthcare Conference live from Las Vegas. It's a pleasure to introduce our next company, Thermo Fisher Scientific with Marc Casper, Chairman, President and CEO. I've covered Thermo since 2003, which is about the same time that Marc got there, so we've been going back a long ways. And wow, what a difference 20 years makes in terms of looking at the company. I think it was $20 and $4 billion in market cap when I picked up this coverage of the stock years ago. So a long way from then. Marc, you want to start off just -- you had a -- you put up -- reported Q1 results a couple of weeks ago. Really just had a strong result on that. You want to talk about sort of what's going on there? I mean, 16% core growth, well above everybody's expectations. Can you sort of set the stage for us at all?

Yes. So Derik, thank you for the invitation. Great to see so many people here at the Healthcare Conference. It's nice to see everybody in person. So really strong start to the year for Thermo Fisher Scientific. Continuation of the trends over the last few years, starting out with 16% core organic growth, really very broad-based strength across our various end markets, our various products, areas, really, no matter how you slice the data, very strong. Orders were even stronger than the revenue growth, so that bodes well for the future. We did a large acquisition that we closed in December, PPD, which adds clinical research services capabilities to the company. Off to a fabulous start. We were able to increase the outlook for that based on the strong start to the year and its wins of new business. So really encouraged by what 2022 holds. And because of the strength of the strength of the start to the year, we were able to derisk some of the macroeconomic dynamics. I'm sure we'll talk about as we thought about our guidance for the year, still actually meaningfully increased our guidance. So it's actually a really great position to be in as we sit here in May.

So I think one of the first questions that we've -- I want to ask is, if you go through the first quarter earnings season, the numbers of the life sciences companies were putting up were crazy, right? I mean, 16% growth with you, really strong demand in [ instruments ] and your -- some of the peers are putting up like 20 -- single or high teens, 20%. I think this has like driven some questions from the investor base is like, is this real demand? Is it sort of like catch-up? Is it stocking? I mean -- obviously, nobody stockpiles $2 million on microscopes. But I mean, can you sort of talk about just like what the dynamics are there? Because the number -- because there's this disconnect because the numbers of the group look really good, yet the stocks trade like they have Ebola.

It is a good analogy. So when I look at the strength of the industry, right, and you come out of the pandemic, right? And you say, so what's going on? Why is the industry has had several quarters of really strong performance, and you see our continued accelerating momentum? If you take pharma and biotech, which is the largest of the end markets, actually, activity is really strong, right? So when you actually look at what those clients are doing in the industry, they're very active and that bodes well for the life science tools and pharma services, that's the capabilities. Academic and government, funding has been good. NIH in the U.S., the European equivalents. There's been strong funding environment there as well. The industrial economy, which is probably the smallest of the end markets, has actually been good. So that's actually in a good spot. And health care and diagnostics, you've seen activity return to that sort of normal growth that you would get coming out of the pandemic where volumes were impacted by the pandemic disruption. So effectively, all 4 end markets are strong, and you're seeing that across the industry. I don't think, as I really look at the activity that we have, I don't think you're seeing any sort of pent-up demand, disrupted demand that people are catching up with. It looks like very fundamental, customers are buying what they're using is what it appears to us.

On the instrument side, to Derik's point, is there -- yes, you don't exactly stockpile those things. But given the last 3, 6 months, everyone in the world is talking about supply chain disruptions, concerns, backlog. Is there maybe some customers that they may have wanted to -- they see an LCMS that's going to have an end of life in 3Q, and they're just putting in the order now ahead of time, just in case disruptions come in because they don't want to be left hanging? So is there maybe a little bit of a timing tied to worries about future supply chain?

Yes. So Mike, what I would say is that given the lead times that exist in the industry, a little bit longer on the instrument side than say, typically, you might have customers order a little bit earlier. But I don't think that really shows up in revenue, actually. I mean, that would show up later in the year. So we have a good set of what our commercial pipeline is and so activity looks very high. So whether customers are placing a little bit more orders a few weeks earlier, only that materially affected really what our performance, wasn't sure about others.

Yes. And on the instruments side, just one more point, is it, again, really strong numbers in AI? Is it replacement cycle? Is it more capacity? Is it new customers? Is it one lab going to 2 labs just because those numbers are very robust? And it seems like it's across end markets, right?

Yes. So when I think about our business, all 3 of our instrument businesses, which is electron microscopy, chroma mass spec and chemical analysis had a good start to the year, I would say that primarily in electron microscopy, you're seeing very strong material science and semiconductor-related demand. Life science is quite strong, but if I said -- what are you seeing outsized demand and you're seeing it there, which makes sense, given the focus on clean energy, the focus on all of the semiconductor-related topics. So demand there has been really good. We continue to launch really relevant products in the chromatography and mass spectrometry business. You've seen that normal cycle of innovation spurring demand. And chemical analysis is probably most tied to strength in the industrial end markets. So that would be the dynamics. So pretty broad-based in the strength. I don't think it's sort of new labs or something of that sort that's really driving much of the demand specifically.

So Marc, there was a -- last year, the big concern was oh my God, Thermo is going to have this massive diagnostic cliff and acquire PPD and diagnostics have actually turned out to be better than expected for the most of the year. Now the concern is, "Oh my god, there's going to be this COVID vaccine cliff, bio processing hole." Can you sort of talk -- on the Q1 call, you did risk your COVID bioprocessing by about $600 million. Can you walk us through the reasons for this? And is this like, is this $1.5 billion that you're now looking at a worst-case scenario? And is it still possible you could do something that's even close to your target? Just sort of like your thoughts in terms of like the derisking of the biopharma.

Yes. So Derik, if you'll allow me, I'll step up a level and then I'll answer the question, right, which is the opportunity to discuss a cliff is an awesome thing, right? It means that we actually generated hugely relevant products and services for our customers, right? So you start there, right? And if I take a look at how we thought about testing, right, world was in a crisis in 2020. We scaled up, had relevant solutions and provided over 1 billion PCR tests around the world, right? I mean, just a staggering number, right? And that allowed us to really help society respond to the pandemic. It enhanced our reputation with our customers. And ultimately, it fueled our ability to accelerate our investments for the future, right? And really, we were able to increase R&D. We increased our capital investments really to accelerate our strategy and ultimately, that yielded us signing up for longer-term growth targets at our September Analyst Day about our long-term growth, which is awesome, right? And one of the things that we did around that back in September was to -- even earlier than that, was actually to derisk the discussion and basically say, if you think about a $200 billion-plus market cap company, the value of testing actually is relatively tiny, right? It's plus or minus $0.5 billion of our NPV or not even, is associated with it, right? So therefore, we just said if we'll serve what our customers need but we're going to have very little in the guidance, and that has served us well. Now I turn to vaccines and therapies, we have supported most of the major vaccine therapy programs, right? And we've had large roles in both and diversified roles, right? We have the enabling technologies. We're providing the nucleotides that will be used in some of the vaccines, some of the active pharmaceuticals that would be the ingredients, if you will, that will be used in the therapies as well as the final packaging form of those products. What we decided based on the incredibly strong start to the year as a company is to effectively take the same approach that we did with testing, right, which is at the end of the day, all of that capacity is going to get repurposed to core capacity because it's literally the same capabilities, right? If you're filing a different biologic or a different vaccine or a COVID vaccine, it's literally the same capability. So eventually, that all transitions. And what we basically said is, we will manage that well. We have always managed those transitions well and that will happen over time whenever the demand wanes. And we took the early start to the year, we still raised our outlook, but we derisked the vaccine and therapy numbers. So we took it from $2.1 billion to $1.5 billion. $2.1 billion is still at the high end of what we can do. $1.5 billion, as I'd say, highly achievable would be the way to think about it. So you can think about that. And we did about $0.5 billion of revenue in the first quarter. So you can kind of get a sense of that. There was nothing underlying. It wasn't like something happened with the demand but rather for a company, if 8 out of 10 questions that I'm getting is around vaccines and therapies, oh my God, we're off target, right, in our messaging, and we just said, let's take that off the table.

Yes, yes. So in other words, you just got tired of talking about that.

Tired about it, but I [ wanted to steer ] about the things that I think are most important for the future.

Yes. So that sort of then leads into the question of a lot of the incoming questions we're getting from investors is like, "Oh my God, there's this concern that there's going to be this massive overcapacity in the bioprocessing space." And it's a little bit different from Thermo because you do -- you've got a supply business, you've got a fill finish business, you've got a drug product business or drug substance business as well like that. So can you talk about how we sort of just think about capacity, how we should think about the underlying demand for the biopharma? Basically for the biotech pipelines.

Yes. So if you go back in time to February of 2020, right, before the pandemic or any of that demand, capacity utilization in our industry was pretty high, right, in terms of all of the bioproduction pharma services, infrastructure support, pretty high utilization coming into the pandemic, right? And what you saw with the demand that was spurred was you're still seeing growth, right, in the normal activities that you would see for non-COVID-related things that continues to fuel investments to support that growth. And then you saw a huge increase in demand related to COVID, right? So the way the Thermo Fisher thought about and the way we acted on our investments is we expanded in the areas that we know we have good strong long-term demand, effectively things that were on our road map and we pulled them forward early, right? So purification resins, single-use technologies, those 2 things would be in the classic bioproduction part of our business, and sterile fill finish, which will be in pharma services, where you're taking a biologic and putting it into the final form to be administered to a patient, right? So those things were on our road map. Our demand profile is very strong. So when I think about the industry dynamics, we feel comfortable that as demand transitions from COVID to non-COVID whenever that happens, that we will be able to fill that up pretty seamlessly. And I also want to get our utilization rates down, right, back to the normal because you never want to be running at 100% utilization rate. It's hard on the workforce, it's too much overtime. It's too much weekend work, all of those dynamics. While it might maximize the last penny, it's not what you want to be at. So you want to get back to that sort of normal deal with the ebbs and flows of demand. So all of that dynamic, at least where we participate and where we've invested and when I look at the industry, I feel very good about the long-term prospects.

And when you talk about that seamless transition and being able to shift COVID to non-COVID, a lot of discussion on fungibility of demand, which turns out fungibility is not an actual word. Can you walk us through that, sort of give us some examples of how that transition will take place, again, across the portfolio?

Yes. So single-use containers is a product that would be used for making a biologic, right? And it doesn't know what -- not that it's a person but it doesn't know what it's being used for, right? And therefore, the slow evolution of more and more of the activity moving from small molecule to large molecule has fueled really strong demand. That's a business that's been growing strong double digits for many years. And therefore, as demand wanes for one product, it could be COVID or anything, the growth we've experienced, the new wins, the early molecules, all of those things fuels future demand. So you move from one to the other. And because we're also quoting long lead times, we're able to bring those things back and improve customer satisfaction. So I think that dynamic is pretty straightforward. On the other activity that we have where you do the transition is really sterile fill finish, where -- they have new tech transfer, right? And so it takes a little bit of time. It doesn't happen in a quarter. It happens over a couple of quarters where you -- as one product wanes, you'll do some work with the customer to validate and then you will move the capacity online. So that's how it works in reality.

On the -- if you sort of think about, stay on the biopharma topic, I mean, you acquired PPD. There was a lot of, I would say, hand-wringing when you did that deal, I think, because people saw it as a services businesses. And my gosh, it's like they don't -- it's not a razor-razorblade company. It's like how do you sort of do this? There's labor costs like this. Could you sort of talk about that deal? And also the fact is, I mean, it grew 20% in Q1, which is just some of the ridiculous number for that and sort of like what's driving the outperformance? And could you sort of talk about the dynamics of what's going on with PPD and sort of like the margin impact?

Derik, you must be hanging out with a bunch of nervous people because I think...

I do hang out -- well...

No, it's funny because I've been in the role a whole while, right, and I have a number of shareholders that are very comfortable speaking their mind because they know that my job is to continually get better, right? Actually, the feedback on PPD, super positive at the time, right, which is a couple of questions about explaining the rationale, but ultimately, just a center of the fairway Thermo Fisher deal, right, in terms of to the common customer base, industry-leading segment, good growth prospects, value-added, very clear about how the combination is better than the individuals. And it's amazing. We've owned it now for 5 months, right? And it's off to an awesome start. It's a great business, performing well, right? First quarter, excellent authorizations, which is sort of the bookings language and clinical research services grew very strongly. We increased our growth outlook from 8% for the year of organic growth to 11% for that business based on the strong start. And we're able to increase the accretion for the first year. And we're going to do a deep dive at the -- at our Analyst Day, our Investor Day next week to give an update on how the business is performing. But it's an awesome fit. The customers love it. Our colleagues are doing well, super cool, right? And we'll add value not just this year but over many, many years, in terms of bringing those businesses to add new value to the industry. And that is why the company has been so successful and will be so successful going forward.

And -- obviously, yes, I do deal with a lot of nervous people, and I put myself in that category, too. I'm -- I haven't survived 20-plus years by not being paranoid.

So Derik, I agree with that fully. It's actually the philosophy that I have, right, which is, especially on M&A, it's about characterizing risk, right? It's because there are many things you can do. There's nothing you have to do. We spend all of our time actually understanding what can go wrong with an acquisition and work our way through it. And until we get comfortable that a downside case is good for our shareholders, we don't pursue it, right? So it's -- we have the same philosophy, so a little bit of poke fun at it. But I take the -- I want to every day wake up and our shareholders to say, yes, Thermo Fisher's doing a really good job for us, right? And I want all of our constituents to feel that way. So I take it super seriously, and I take the same view, which is I always start out with a skeptical view as well because if you don't, then you get yourself into trouble pretty quickly.

Yes. Do a pre-mortem as opposed to a post-mortem, I would agree. Yes. Speaking of nervousness, I mean, biotech keeps coming up, [ biotech mundane ]. Can you sort of like characterize that? I mean, we don't see it as an issue but it's topical for a lot of investors.

Yes. So our pharma and biotech end market is super robust, right? If you look at the strength that we had of mid-teens growth in the first quarter, consistent with the very strong growth that we've had over many years at this point in time, right? And orders were very strong and the pipeline is very strong. So it feels very much of a continuation of that momentum that we have. Obviously, when I quote the mid-teens, I'm not including PPD in those numbers, obviously. That business is entirely pharma and biotech, and it grew 20%. So it gives you a sense that it's really quite robust. And I think it's healthy for investors to ask questions about the health of the end markets. When we think about it internally, they're strong and they look good. And it's our job to support our customers. We have managed through periods of time when pharma and biotech went through the patent cliffs of many years ago, and we've helped our customers through that. And actually, it was a period of good growth for us, even though that the end market was tough. But at least as what we're seeing today, it looks very strong.

And speaking of end markets, let's talk China.

Sure.

So an update on how the business performed in the quarter, sort of what's going on with the lockdowns, sort of like how that's impacting your business?

Yes. So #1 priority is the health and safety of our colleagues, right? And that's how we've operated as a company forever. And so for those colleagues that are based in the Shanghai area, we've been able to have a series of food and kind of things that colleagues need from a survival and health standpoint, right? So we've been able to arrange that, and that is our #1 priority. So the situation is challenging. Business actually performed very well in the first quarter with 12% growth in China. We're assuming based on what our team is seeing. Most of the country is actually in pretty normal activity, right? So what they're expecting is disruptions in the Shanghai area. We said for the company is probably about a 2 point of revenue headwind in the second quarter based on what's going on in China, but that will normalize over time. So we would expect by later this quarter, things return to normal in the Shanghai area as well. So that's what we're assuming. And the fundamentals in China are continuing to be strong in our industry, so that's positive. And right now, it's really just managing through the disruption. In our industry, we do get quite a bit of exemptions to actually work. So it's not as if there's nothing going on in Shanghai with our business because the government understands the role we play. So it's nuanced. It's not like on-off. It's just certain customers are closed, certain customers aren't closed. The ones that aren't closed, we're able to support. The ones that are closed right now, there's no activity.

I mean, you don't have a consumer-facing business in terms of...

No, no, we're supporting the pharmaceutical companies, et cetera.

Yes. And this sort of goes into the next, I mean, it's -- once again, looking at the history of the company, I mean, when I -- when it was Thermo Electron, when I picked it up, it was like 80% capital equipment, you still have had [ Spectra-Physics ]. As investors start worrying about recession scenarios and defensibility of the stock, defensibility of the business going to a more uncertain economic time, how do you think about the performance of the company and today versus where it was, say, during the Great Financial Crisis and [ lifeline ]?

Yes. So a few things, right? One is probably the most important message, right, is as we look internally today, right, at this moment in time, actually, leading indicators are very strong, right? Business is performing really well. So it's not that -- I'm not ignoring what's going on in the world, but I say actually what's happening within the 4 walls of our business, the world is really very positive. So that is what it is right now. In terms of recession and one is the management team has managed through 3, right? And the COVID-related one, the Great Financial Crisis and the one in the early 2000s, so we've been there. And what I would say is for investors that may not have thought as much about it first, from an industry perspective, awesome industry, right? The demand profile in this industry is incredibly resilient relative to most parts of the economy. So that's the first aspect. The second aspect is Thermo Fisher. And given the share gain that we've had and how we performed has performed better than others in those periods of time. So we've got a proven track record and actually exiting those periods stronger. And since the Great Financial Crisis, which is really a good way to compare and contrast, we've evolved the mix of what we do pretty meaningfully, right? So if you think about the Great Financial Crisis, at the trough, we had negative 4% organic growth, right? So that gives you the magnitude of what it was at its worst year. At that point in time, roughly our industrial and applied end market was about 30% of our revenue, right? So that's going to be a most economically sensitive one. Today, that's 13% of our revenue. Back then, the instruments capital equipment was about 35% of our revenue. And today, it's about 18%, right? So that has shifted hugely in terms of services and consumables, which are -- which moved much less than capital equipment. It's about 82% of our revenue and pharma biotech, which also is the end market that moves the least from an economically sensitive standpoint is about 55% of our revenue, which was 24% of our revenue before the financial crisis. So the company actually is quite a different profile, and it gives you a sense of how resilient it was even with the old profile. So we don't want a recession and they're hard to manage through but we're super well positioned. And it really is an incredible safe haven as an industry for -- from an investor standpoint because you take a lot of the volatility out.

On the topic of supply chain and global disruptions, I mean, the way we've heard it characterized by some of your peers is that it hasn't exactly been smooth sailing. It's every single day, they're trying to put out 100 different fires and 100 different supply chain channels. And the further we go into 2022, there's more and more problems arise. And it's kind of a game of how many holes can you plug before something breaks down. So would that -- would you agree with that characterization? Sort of how much visibility do you have going forward? And how are you staying on top of all of these disruptions?

Yes. We have -- I'm not sure exactly that characterization, but there's definitely supply chain challenges that are real. We have an incredibly disciplined operating mechanism, our PPI business system. It gives us really strong capabilities to navigate through challenging times, and our team is doing a good job of working with our suppliers and helping them to be able to support the growth and the performance that we've had. And where you see some challenges in electronic components and the team's doing a good job of navigating that. You definitely see some challenges in freight and cost around freight, so there. But we're managing it, and we'll continue to focus on it, and we're good about anticipating where challenges are. And it doesn't mean there won't be something unexpected, but so far, the team has done a good job in navigating it.

And on the other side of that, on the price. You've taken more price this year. Is it -- given the diversity of portfolio, could you give us a little bit of clarity? Are you taking the same amount of price across the board? Or are there some areas where you're seeing 10% price and another 0 and it kind of averages out to that level? Is it by customer, by product, geography?

Yes. So this is a good industry and when I think about pricing, historically, you would get, in a given year, 0.5% to 1% price across the portfolio. It will be at least double that this year. And it is -- we do a lot of work for our clients. So it really is very candid discussions about where we're seeing cost pressures. So it's not the same price increase across the board, but it's logical. I had a lot of discussions that say, hey, freight costs are up. This is what we're doing about it. This is what -- how it affects pricing or we're paying more for an electronic component. Here's how we're thinking about it, and we've been able to execute that well. So it's not sort of, hey, there's an opportunity to just go out and grab money, but rather to thoughtfully manage pricing to do a great job for your customers so they want to do more business with you over time.

Some markets were sort of winding down right now. You've got an Investor Day coming up. I mean, I think last Investor Day in September, you raised the core growth guide longer term to 7% to 9% organic. I guess what sort of gets you to the -- what do you need to see to sort of get you to the higher end of that range, right? And care to give us a preview of next week?

Yes. So we're looking forward to seeing many of you in New York for our first in-person Investor Day in a while. And we want to get back on the May cycle, right, which is -- so we decided to go back to what we normally do. And so we'll -- we're looking forward to that. I'm super excited about the growth prospects of the company and the ability to deliver consistent long-term 7% to 9% core organic growth. The end markets are strong. They've got great demographic trends around them. And our proven growth strategy as we're working. That's allowed us to grow faster than the market for many, many years. And we're incredibly well positioned to continue that and deliver spectacular results for our shareholders, taking that top line growth, expanding margins and ultimately delivering mid-teens EPS growth in the long term, so which is great, and we look forward to telling you more about it next week in New York. Derik, thank you so much for having us today.

Thank you. No, and we're right at the bottom of the hour, so thanks, everybody. Thanks, Marc. Always a pleasure and congratulations on just a tremendous success.

Thank you.

And thanks, everybody, and be safe. Have a good conference.