Thermo Fisher Scientific Inc. (NYSE:TMO) Morgan Stanley 20th Annual Global Healthcare Conference Call September 12, 2022 9:55 AM ET
Company Participants
Marc Casper – President & Chief Executive Officer
Conference Call Participants
Tejas Savant – Morgan Stanley
Tejas Savant
All right, guys. Good morning. Thanks for joining us. My name is Tejas Savant and I’m the Life Science Tools and Diagnostics analyst at Morgan Stanley. It’s my pleasure to host Marc Casper, CEO of Thermo, so Marc, thank you so much for joining us this morning.
Marc Casper
Pleasure to be here.
Tejas Savant
Before we get started, just a quick disclaimer I have to read off. For important disclosures, please see the Morgan Stanley research disclosures website at morganstanley.com/researchdisclosures. If you have any questions, please do reach out to your sales rep.
So with that, Marc, we’ll kick it off. Maybe just to set the stage, can you just talk about your — what you’re most proud of through the last couple of years that the company has accomplished? And as we head into ’23, what excites you the most?
Marc Casper
So Tejas, thanks for having us and it’s great to be back in New York to kick off the final 1/3 of the year. So it’s been a great few years with Thermo Fisher Scientific. You see the benefits of our growth strategy and the discipline of our PPI Business System delivering really strong financial results. And when I think about this past year, in the first half, really an exceptional performance. Results are very strong. We continue to grow faster than our industry, delivering very strong profitability. We’ve been able to raise our guidance a couple of times. Our largest acquisition in our history, PPD is performing at a very high level. We were able to raise our synergy targets. So things are continuing that trend of very strong performance.
And having been at the company for a long period of time, we’ve navigated through many different dynamic times. And I’m sure we’ll talk about that today. And we live in dynamic times today but the company is performing truly at a fantastic level.
Tejas Savant
Got it. So obviously, Marc, one of the key themes in people’s minds at the moment is the risk of a recession. Can you just remind us how the company performed during 2008 and how it has evolved since then? Beyond just the product mix, what is it that makes Thermo more resilient than some of your peers?
Marc Casper
Yes. So when you think about, first, our industry in terms of how does life science tools and diagnostics act in recessionary times, this is a good sector to be in, right, in terms of we declined 3% organically during the Great Financial Crisis for 1 year and then rebounded very sharply right off of that. So in terms of how big the movements are, they typically are quite muted.
When I think about how the company, how we’ve evolved our mix by executing our strategy, the company is — has a more favorable set of end markets than we did back at the end of the 2000s. And today, pharmaceutical and biotech which is the least economically exposed end market, represents just under 60% of our core revenue. And back then, it was about 1/4 of our core revenue. And our consumables and service business is about 85% of our revenue. Back then, it was about 2/3 of our revenue. So the company’s mix has evolved and that positions us to navigate whatever the world throws at us. What I do think is important is that what we’re seeing today continues to be very robust demand in a very strong environment.
So there’s many things that we worry about and I worry about as a global business leader but we’re not actually seeing them at this point translating into our business.
Tejas Savant
Got it. We’re hearing from some of your smaller life science companies in the space around just challenging dynamics in Europe. Can you talk to us about your business profile in the region? And how are you managing the difficult conditions there, particularly as they relate to FX and the energy prices?
Marc Casper
Yes. So when I think about the different factors and we’ll talk about Europe but maybe in the context, right, as a management team, it’s our job to navigate what the world throws at us and to create opportunities whenever there are challenges, right? And there’s always going to be something that we all can worry about and Europe is a good area to pay attention to.
Today, Europe represents about 20% of our revenue, so that gives you a sense of the scale. Our core business actually performed extremely well in the second quarter. We grew in the high single digits in terms of the organic growth in our core business there. And we have significant exposure to pharmaceutical and biotech like our global presence. Europe is probably slightly more heavily weighted towards pharma and biotech, so more, I’d say, resilient. From an energy availability perspective, our business continuity plans have been engaged months ago to ensure that we can supply our customers without disruption. And we’ve converted our larger sites from natural gas to other forms of energy so that we’re able to navigate through the winter. And however it plays out, the discipline of our team will be able to navigate through that.
Our goal is to navigate it better than anybody else in our industry. How good that will be, I don’t know because we’re not sure what we’ll face but that’s how the standard we hold ourselves. We’ve got to be the best managed business in life science tools and diagnostics.
Tejas Savant
Got it. One of the things that you guys have really done well over the past couple of years is navigating the supply chain challenges. Can you just share a little bit of color on how you’ve managed that, particularly like things like chips and electrical components and so on? And looking ahead, how do you see supply chain conditions evolving?
Marc Casper
Yes. So there are real advantages from scale, right and the scale of the relationships you have with your suppliers, the importance you have to those suppliers and when the world face challenges that we really haven’t faced in the past which has no one really thought about. I never spend a moment thinking about semiconductor chip supply other than the last couple of years. Just you’ve ordered you got, right? And then all of a sudden, the world changed. But the strength of our operating teams really have allowed that to be a nonissue for us, right? And the same thing on freight and logistics. There was a period of time where we’re escalating costs and there were challenges.
But again, we were able to manage that in a way that had pretty minimal effect on the business and we were able to give really strong organic growth through that period of time and good earnings performance as well. So it’s really a credit to the operating discipline and the benefit of scale.
Tejas Savant
Got it. You’ve managed to manage inflationary pressures by realizing price that’s approximately 2 to 3x higher than historical levels. How do you see pricing evolving next year? And is there a point in your mind where that starts to sort of hurt customer demand?
Marc Casper
Yes. So Tejas, when I think about pricing, first of all, take a historical perspective, pre the sort of inflationary period that we’re living in. Really good industry and we have really good discipline around pricing. And in a given year, we would get 50 to 100 basis points of price every year. And that’s part of our economic formula in terms of high single-digit organic growth and you say you’re getting 0.75 point on price. So that’s the norm. When I think about how we’ve operated in the current environment, because we’ve been a good supplier, a good partner for our customers, we have a very transparent dialogue. And we talked about what additional productivity we could drive in a more inflationary period and what we’re taking on our shoulders and what is appropriate for us to pass through to our customers.
And we — in the first half, we were running 2 to 3x the high end of our historical rate in terms of pricing. And we expect an additional about $100 million of price in the second half of the year just based on some of the inflationary pressures that are out there. And when I think to the future, we will price appropriately based on the economic environment. So we’re not a company that’s looking for, how do you maximize price? What you want to do is how do you maximize the long-term value of your customer relationships and do a great job for them. So it will be an open dialogue based on what the environment is and what’s the appropriate level of pricing. And I feel that we’ll manage it appropriately as we get better clarity to what the cost environment will be in 2023.
Tejas Savant
Got it. And given some of these macro challenges, including the energy crisis, Marc, do you anticipate any changes now, government agencies support research funding globally?
Marc Casper
Yes. So when I think about academic and government as a proportion of our business, it represents less than 20% of our end market, an important customer base for us. When I look at the funding levels, they’ve been really good and there’s been strong commitment. So I’ll give you a couple of examples. Obviously, the CHIPS and Science Act is a real show of support from the U.S. government on the importance of science and investing in an industrial policy of which our academic customers will certainly benefit from that. And when I think about what’s going on in China and the very active dialogue we have with the Chinese government, there’s real commitment to investing in innovation and technology there as well. And those are 2 of the bigger markets where kind of government policy makes a difference.
European funding has been good, right, in terms of the various life sciences initiatives, both in the U.K. and across the EU. So while there is some economic sensitivity, it’s typically not short in nature. It’s typically in the budgeting cycle. So if you’re seeing a more challenging environment, it may show up a couple of years later.
Tejas Savant
Got it. So you put all of this in a blender and investors want to know what does ’23 look like. Is there any color in terms of the puts and takes as we think about top line growth and perhaps more importantly, the operating margin next year.
Marc Casper
Yes. I want to know what ’23 looks like also but we’ll see. And I think our convention is really the following which is we benefit from understanding how we actually finish at the end of the year and then we give a tremendous amount of detail around what our outlook will be for the year. But there are some things that we know today or have a view on today that is worth highlighting for our investors, right? So when you think about 2023, a few of the assumptions. One is foreign exchange which has been a very significant headwind this year. Will still be a headwind next year but not quite as dramatic. So if you use the exchange rates at the end of July, that would effectively lead to about a $600 million revenue headwind and about a $0.40 EPS headwind kind of give a magnitude. So probably about half of the headwind that we had faced in this given year.
When you think about testing, our guidance for this year is about $2.6 billion of testing revenue. We’re assuming an endemic level next year which will be about $400 million to give you an order of magnitude. We’ll know that better as the pandemic plays out but at least it dimensionalizes that view. And we’ll have a good sense of what our core outlook is as it gets closer. But what we do have a confidence is because of the performance in the first half is that we will finish the year at a higher level of revenue than we had expected when we gave our long-term model. So that gives us real strong momentum going into 2023. And as I think about it, we’re actually on track for our 2025, 2026 goals, right, in terms of where we are at the end of ’22.
So, I would expect that the performance we put out in ‘23 will put us in a position to be able to achieve the long-term goal. So it’s actually a position that we’ve incorporated with the different factors and feel good about them.
Tejas Savant
Got it. Switching to a point you just mentioned as part of the framework, COVID testing and vaccine contribution. Can you just give us an update in terms of the demand you see today for vaccine and therapy production?
Marc Casper
Yes. So we did — we’re expecting to do about $1.5 billion this year in terms of vaccine and therapy revenue. We did about $900 million in the first half, so we’re expecting roughly $600 million in the second half of the year. And that is a broad-based set of activities that we do to support both vaccines and therapies. Our sterile fill finish is used for both vaccines and therapies where you’re putting the — either the vaccine or the therapy in the final form to administer it. We play a large role in the provision of purification resins and cell culture media technologies used, enabling technologies used to produce those COVID therapies and vaccines as well as some of the enabling technologies, nucleic acids as well for mRNA. So it cuts, of course, different parts of the business. And we feel good about the outlook. And we kept all of that in our core growth because the capacity is repurposable to other medicines, right? So in sterile fill finish, if you’re not filling a vaccine, you’ll be filling a different medicine and we’ll transition that capacity at the right point in time to other uses.
And when you think about the $1.5 billion, what that says is it’s at a similar level to the prior year, right? So when you look at the growth of the company, it’s really coming from a stable level of COVID activity and you’re seeing the growth coming from the non-COVID activity that we have.
Tejas Savant
Got it. And as we look to ’23, what in your mind, Marc, is a derisked sort of run rate for COVID vaccines and therapies? I mean, is $1 billion sort of a fair best guess at this point, knowing what we know?
Marc Casper
Yes. We’ll come up with the appropriate number as the year finishes and we get final visibility and we may have an update on our third quarter call at the end of October. So we’ll come there. But whatever the number is, if it’s not COVID-related, we’ll have other capacity that we’ll be bringing online to fill that demand if it’s not COVID.
Tejas Savant
Got it. You obviously did a really good job expanding your PCR installed base through the pandemic for COVID testing. What are you doing to ensure that the instruments you place then continue to be used? And can you also comment on your menu expansion sort of effort?
Marc Casper
Yes. So on testing, I think it’s worth kind of putting things in context, right which is — pre-pandemic, we were a smaller player in molecular diagnostics. And we had all of the technologies but they were primarily used in research applications, both our sample preparation as well as our qPCR instrumentation. So you’d find them in every research lab around the world, every public health lab but less of a presence in the clinical space. We were able to scale up both with the regulatory process, getting approvals and scaling up manufacturing faster than anybody else in the industry in molecular diagnostics where we wound up with a very large share of the qPCR-based COVID testing around the world. That led to a huge installed base increase of lab-based qPCR instruments, lab-based sample prep instruments. And we did an acquisition during the pandemic to give us also point-of-care-based PCR.
So a very large fleet of instruments and what you’re seeing is us not only continuing to support our customers in the fight against COVID but also adding menu as the way you frame your question. So if I take those 3 pieces, starting with the rapid systems where you’re getting a result in about 30 minutes, we’ve added the different respiratory test, flu testing for this upcoming season that we’re just about to be in. So that customers can use that in a doctor’s office or a MinuteClinic or those types of things for a rapid turnaround. And that will continue to be relevant and we’ll add menu to that over time.
In sample prep, because of the very large installed base and the build and the strong performance that we had, again, those instruments will support other molecular applications beyond respiratory. And then finally, in qPCR, we have been launching panels of infectious disease testing, including respiratory and ultimately, we’ll be focused on things like sexually transmitted diseases to continue to keep that installed base effect. And what we’re assuming is at least we’ll be generating a $400 million run rate of activity going forward based on that. And it will likely be over time more than that as we build out the menu.
Tejas Savant
Got it. One follow-up that just came in over e-mail here. Are there specific modalities where a transition from COVID work to non-COVID work in terms of biopharma services can take longer versus instances where it’s essentially fungible in real time?
Marc Casper
Yes. So when you think about the different types of activity, there are activities where literally, you clear the line and you can produce the next product. And you visualize it like cell culture media, purification resins, we supply the industry. And other than you may have a different formula, if you will, a different recipe, it’s really just demand-related. It’s not capacity or transition-related and that’s a big part of the activity. And things like sterile fill finish, given the volumes you’ve had for the vaccines, what you really have here is this tech transfer, right which is what that means is that you actually have to qualify your facility for the new capacity. And we have quite strong demand but you have to go through and say, all right, how do I ramp-up additional capacity?
And that’s a thoughtful process of which we’re undergoing some now. And we have customers lined up in the future as well so that at the right points in time, we’ll be bringing on capacity. So there’s a lag between when capacity wanes and when capacity comes up. But you plan for that in terms of how you deal with them.
Tejas Savant
Got it. And can you provide us with an update on how the CDMO business is performing? We’ve seen some companies focused on building in-house capabilities, particularly for these newer modalities. What are you seeing in terms of outsourcing trends today?
Marc Casper
Yes. So we are one of the largest of the contract developers and manufacturers for the pharmaceutical and biotech industry. And we run across a full range of capabilities from drug substance, where you’re making the active pharmaceutical ingredients for high-value small molecules and large molecules as well as drug products. And we do that for both small molecule, large molecule and some of the advanced modalities, right? So we’re a full-range provider. Business is performing at a very high level. Second quarter was excellent growth. We’ve seen very strong demand. I was at — a couple of weeks ago, I was at the opening of our new facility in Plainville, Massachusetts. It’s probably the largest viral vector facility in the world used to support cell and gene therapies. And we had great customer attendance, right? They’re excited by what we’re doing in terms of the capabilities we’re bringing on.
So when I think about the outsourcing trends, because more and more of the work and the discovery, if you will, is happening in the smaller companies, those companies typically don’t have manufacturing networks and therefore, they leverage partners. So the high-level macro trend is in favor of partnering. Some of the larger companies, they have to make versus buy and we’re winning and collaborating with large companies. And many prefer a partner and there are others that prefer to do it in-house. And when they’re doing it in-house, we support those efforts as well with our enabling technologies.
So, we’ll participate in either fashion and be able to support the industry. But that’s a business in aggregate. That’s one of our faster-growing businesses and we have a very strong competitive position.
Tejas Savant
Got it. PPD has clearly performed well for you. At the Investor Day, you raised your synergy outlook there. Can you just give us an update on how that’s going? What gave you the confidence to raise targets 6 months post close?
Marc Casper
So Tejas, we closed our acquisition of PPD which was a little over $20 billion acquisition, in December. And when we thought about it, we knew that our customers would appreciate us adding the capabilities of a leading contract research organization to support their efforts in discovering and developing medicines. And we had high aspirations for the business and it’s far exceeded the early read as we sit here 9 months, 10 months post close.
The business performed incredibly well, right? And we were able to raise our outlook for the year. We’re at about 12% organic growth for that business. We’ve increased the earnings outlook and we’ve meaningfully increased the synergy outlook. And that’s both on the cost and revenue side. From — at the May Analyst Meeting, we increased our revenue synergies by about $100 million and with a $25 million pull-through. We did that purely based on the wins that we’re seeing in terms of new authorizations of work based on the combination. And then we also increased our cost outlook by $25 million.
When I think about the early days of the acquisition, customers that have been long-standing Thermo Fisher Scientific customers that might have used PPD in a more sparing way has given us the opportunity to work with them. So we’ve won a meaningful number of new customers, some very large ones. And now it’s our job to really exceed expectations. We do that. We’re really going to have an incredible combination. So it’s early but very positive.
Tejas Savant
And what about sort of the customer wins on the other side where PPD introduced you guys to a customer where perhaps Patheon or Brammer did know about them? And now they’ve come in. Can you just talk about that a little bit?
Marc Casper
Yes. So the first real synergy area that’s been exciting in terms of where we might have the clinical trials, research work has been in our clinical trials packaging business where we’re doing effectively securing the drug supply and packaging and labeling it, securing comparative drugs, things of that sort, blinding them. We’ve had a number of wins where effectively it’s enabling the physical aspect of a clinical trial in addition to the — all of the paperwork and all the administration of the clinical trials. So that’s been the first set of wins that we’ve had from a synergy perspective.
Tejas Savant
Got it. And can you remind us of your suite of capabilities to support cell and gene therapy? How is customer demand here? I mean, how has it evolved over the last 12 months or so? And what are the key priorities for customers in this area on a go-forward basis?
Marc Casper
Yes. So when I think about cell therapy and gene therapy, we have made a series of investments over the last few years to ensure we have the enabling capabilities to facilitate customers, bringing these breakthroughs to benefit patients, right? And on the gene therapy side, we built out our viral vector network first through an acquisition of Brammer Bio and then adding 2 new facilities in the U.S. We added additional acquisition through European facilities and have really built a global network now to support the industry. And that’s been very positive. And on the cell therapy side, we have a collaboration with UCSF to bring on a services capability in the Bay Area as well as significant investments in the enabling technologies to be able to standardize the production of cell therapies at the major medical centers around the world. So that’s been how we’ve been playing in that market. And I see the growth prospects to be strong.
And what really the goal, right, is there’s tremendous promise in the medicines in terms of patient benefit. But the goal is to get the cost to be affordable, right? And in these medicines, it’s really around the manufacturing costs are extraordinarily high. And the reason we’ve made the investments here is really to drive the experience curve down to reduce the cost, to have all of the learning to enable the industry. And we’re excited about the progress we’re making and that’s our goal, right? If we can bring the cost down, it means that more patients are going to benefit and our customers will be investing to really tap into those capabilities.
Tejas Savant
Got it. You spoke about the facility you just opened in Massachusetts. You obviously have the Nashville site come online as well for your single-use bioprocessing and fluid transfer assemblies. Can you just remind us where you stand in terms of that $650 million multiyear capacity investment plan you’ve laid out last year? What remains to be done? And has the mixed macro picture made you sort of scale back a little bit or is it still full steam ahead?
Marc Casper
Yes. So Tejas, from the context standpoint, as you know, 2020, 2021 and 2022 as well, we had an extraordinary positive contribution to our economics because of the COVID response. And one of the things that we did is accelerate the investments we had on our long-term strategic plan. So we thought about facilities that we were going to bring online down the road. We had such strong demand. We actually pulled forward a number of capital investments.
And in the area that you highlighted, bioproduction, we went on the $650 million expansion to bring on new single-use capacity and to bring on new cell culture media and purification capacity. And we’re largely through those investments. So Nashville is the largest of our new facilities that came online last month. We’re ramping it up. And demand has been strong, right? So we really were able to enhance our network for single-use. I was in Grand Island, New York to see the expansion of our cell culture media facility and the same [indiscernible] Massachusetts on purification. So we’re finishing up those investments and bringing them on.
And demand has been good so we’ll grow into it. And most importantly, we’ll be able to bring lead times down for our customers which have had to really wait because of the surge in demand that was created by COVID really stretched our lead times across all of bioproduction and we look forward to getting back to more normal lead times for our customers.
Tejas Savant
Got it. Switching gears to China, Marc, that’s been a bit of a topic du jour there. It’s an important region for you. You’ve managed to offset some of the disruptions with testing and strength elsewhere in your portfolio in China. Can you just share your latest thoughts on the pace of the recovery? There’s been recent news around the shutdowns in Shenzhen and Chengdu. So just curious as to what you’re seeing in the region.
Marc Casper
Yes. We have about 9% of our revenue in China. It’s a fast-growing market. We had a very strong second quarter, both in our kind of core business as well as helping the government respond to the pandemic. The team has done a remarkable job managing through the lockdowns. And based on the relations we have with the Chinese government, I think you’re going to continue to see rolling lockdowns and we know how to manage through them. And we’ll do a good job of growing our business and helping our customers and work through a challenging world.
There’s going to be geopolitical challenges in China. They’re real and in certain of our technologies, we’ll have restrictions. But for the very vast majority of what we do, it’s business as usual. And that’s a business that has grown in the teens for a long period of time.
Tejas Savant
Got it. And that’s actually a perfect segue into my next question, Marc, around, do you see a need to sort of evolve your China strategy, given what you just mentioned around geopolitical sort of evolution there between the relationship? Or are you pretty comfortable with you’re in China for China sort of approach?
Marc Casper
Yes. Most of what we do within the country is to support the country itself, right? So you’re seeing us, over time, migrate the technologies that are more commoditized but more routine, if you will, to the country for local production, that gives customers the comfort that they’re going to get the quality and the reputation of Thermo Fisher Scientific but not have any concerns about product availability. So we’ve migrated some production, over time, to the local market.
And the business is really performing at a high level and we’ll feel good about what the outlook is there. And we’ll make sure that we’re in compliance with whatever challenges that we need to, to make sure that we are following every rule from the West.
Tejas Savant
Got it. I’d be remiss if I didn’t get in one on M&A. Just curious as to your deal pipeline today, particularly on the valuation pullback here. And given that you just completed PPD, what is your appetite to do a larger transaction? Would you be willing to take on a little bit of leverage for that to happen?
Marc Casper
Yes. So the business is performing well. And when I think about the outlook, it’s very strong, right? Our pipeline is busy and you’ll see us be active, right? We’ll follow our disciplined approach of deals have to strengthen the company strategically. They have to be valued by our customers and they have to create meaningful shareholder value, including in a downside scenario. We manage the risk side of the equation and we’ll continue to be active and I feel good about what the outlook is.
Tejas Savant
The other question that comes up ever so often, Marc, is as you consider an asset to plug into your deal pipeline, how do you think about sort of profitable companies that are already market leaders versus exciting emerging technologies? What are some of the criteria you use to evaluate each of those buckets?
Marc Casper
Yes. I mean, most of the transactions that we do, at least by the volume of dollars invested are going to be in businesses that have profitable growth and we can accelerate their growth, right? But we do make acquisitions of emerging technologies. They don’t get a lot of headlines because they’re small, right? An emerging technology might add $10 million or $20 million or $30 million of revenue. You might have a lot of prospects but in a company of our scale, we’re not going to talk about it very much. So you’ll see us add things periodically on that front. But most of where the M&A dollars go is really just great additions to the portfolio.
Tejas Savant
Got it. Last question. What keeps you up at night as you think about 2023? Or do you sort of like sleep comfortably knowing that you’re going to do better than pretty much all of your peers?
Marc Casper
My kids are in college so I sleep much better. There’s no disruption. But the way I think about it, really the only thing I worry about is complacency, right? We have a very strong industry leader with a very proud history. But what’s all that is relevant is that we create a bright future. And as long as all of our 125,000 colleagues show up to work every day and understand that, that we got to earn our business from our customers, that they’re making a good choice to select Thermo Fisher Scientific, there’s nothing that I worry about. And so that’s what I pay attention to and make sure that we’re bringing our best every day.
Tejas Savant
Got it. Thank you so much, Marc. We appreciate the time.
Marc Casper
Great. Thanks.
Question-and-Answer Session
End of Q&A
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