Thermo Fisher Scientific's CEO Presents at Morgan Stanley Healthcare Conference Call (Transcript)

Sep.10.13 | About: Thermo Fisher (TMO)

Thermo Fisher Scientific Inc. (NYSE:TMO)

Morgan Stanley Healthcare Conference Call

September 10, 2013 11:10 AM ET

Executives

Marc N. Casper – President and Chief Executive Officer

Analysts

Daniel Brennan – Morgan Stanley & Co. LLC

Daniel Brennan – Morgan Stanley & Co. LLC

Great. Hi, welcome I’m Dan Brennan, Morgan Stanley’s Life Science Tools and Diagnostics Analyst, and I’m here with Marc Casper, CEO of Thermo Fisher Scientific. Before we get started for any disclosures related to this presentation and others you could go to the Morgan Stanley website at www.morganstanley.com/researchdisclosures.

Please enter the date to raise your hand on the presentation. I’ve certainly have a list of questions to get through, but I would welcome audience participation, so we’ll try to get a microphone on the spot or over to you all, so Marc thank you very much for being with us today.

I thought we start out by just focusing on the Life transaction out of the gate and then we could talk a little bit of the code of Thermo and some of the business trends and some of the opportunities there. And maybe this is a high level question Marc to start off with; you’ve had time – further time to get to know kind of Life’s businesses, lot of their employees as you travel around the country.

Maybe you can share some additional insights with us about, what are the key benefits of this transactions for Thermo shareholders that that they wouldn’t be able to achieve by buying the stock separately?

Marc N. Casper

So Dan thanks for having us. As we exit the summer and get ready for the close of the Life Technology transaction early in 2014. We’re very excited about the combination and when we look at that, we see substantial synergies between the business, which we outlined back in April. We’ve had our integration planning teams continue to do work over the last few months and feel very confident on our ability to achieve the synergies.

On the revenue side, we see substantial opportunities on revenue synergies. We’ve assumed of $75 million of revenue synergies by year three and obviously trying to generate more than that over time, coming from three primary areas. The first of which is leveraging the strong e-commerce channel that Life Technologies has adding additional products from Thermo Fisher to those applications.

The second is using the combined company scale on emerging markets to really accelerate our growth on the highest growth regions of the world. Thermo Fisher has historically had great strength in China and we’re going to try to replicate that in a number of other markets. And then the final areas in some of our large accounts with Thermo Fisher historically has had very strong relationships to use those relationships to create new and differentiated aspects with some of Life Technologies offered.

Daniel Brennan – Morgan Stanley & Co. LLC

Great, okay. I know there is a quick question on the regulatory side which I think in the past kind of the regulated – technology do but nonetheless is there any update or any information to provide about kind of China, U.S. timeline things of that nature?

Marc N. Casper

Not much has changed continuing to progress according to our plans. So we’re still looking in early 2014 close and our teams and advisors are working closely with the three primary governments to complete that process.

Daniel Brennan – Morgan Stanley & Co. LLC

Okay. Maybe we can kind of dig a little bit on synergy targets which you just kind of begin to assess from a high level, I mean the targets to look as we mentioned on the conservative side certainly by historical standards maybe can you give us a sense certainly on kind of a call side of the equation, what are really the opportunities, you have outlined some of the public company cost and you’ve discussed not wanting to touch any decline facing kind of people or businesses but nonetheless how should we view kind of the level of cost synergies that you’ve laid out?

Marc N. Casper

Yeah so when you look at the synergies we articulated $250 million of cost synergies and $25 million of earnings from the $75 million of revenue synergies by year three. When we look at that and look at our historical track record, our M&A, we always make the cost targets and we think those are the right assumptions and our job is to execute well against that and feel that a third of the cost synergies will come from eliminating public company cost and duplicate general administrative functions or about two thirds of the cost are leveraging the scale or things like procurement, savings as well as consolidating some of our businesses into the Life Technologies infrastructure. So that’s where it’s coming from. But when you look at the assumptions more in the revenue side, I think we’ve seen more upsides there and that’s really where we’re going to be focused on trying to drive sustainable organic growth for many years into the future.

Daniel Brennan – Morgan Stanley & Co. LLC

I think you’ve discussed since the deal was announced maybe some opportunities particularly with Life’s Diagnostic portfolio marrying it with Thermo, NGS, qPCR and the likes what can you kind of tell us about the opportunity to maybe putting these two businesses together from a diagnostic standpoint are there really topline synergies and opportunities there?

Marc N. Casper

Yeah. So the companies both have very strong presence in life science tools with Life Technologies great strength and qPCR great strength and next-gen sequencing and a number of other important categories Thermo Fisher also has a $3 billion specialty diagnostics business which Life Technology does not have and that’s a huge advantage for the combined company because we have the regulatory infrastructure, the commercial infrastructure globally to reach those customers and effectively every major hospitals around the world is a Thermo Fisher customer.

So our intention is to help accelerate the penetration of qPCR next-gen sequencing into the clinic by leveraging the capabilities that Thermo Fisher has and supplementing with new technologies that Life Technologies brings.

Daniel Brennan – Morgan Stanley & Co. LLC

Okay. So one of the push backs in the front on the transaction is possibly Life’s growth rate might be a determent to the pro forma growth rate combined entity and I know you’ve discussed when you first laid out when you presented the deal, you were assuming kind of the 3% growth rate going forward for Life, but I think you also hinted that possibly towards impossible inflections to that growth. So as soon as enter to understand why kind of how you arrived at a 3% number any kind of higher level color you could provide to give investors confidence about that concern about being dilutive to the growth?

Marc N. Casper

Yeah. So when you look at the topline historically Thermo Fisher Scientific has been a mid-single digit grower so 4% to 6% organic growth and you look at the recent performance within Life Technologies, a bit more in that 3% range and that really has been because of some royalty runoffs that were substantial, some specific headwinds in some businesses that we’re going to transitions. Those headwinds, we think alleviate, which gives us confidence that the 3% growth is a reasonable assumption going forward. That’s not our aspiration per se. But I think from a planning perspective, I think that’s a reasonable perspective.

And so when you say the combined company, you have roughly a $13 billion company in the mid single-digits, to say a $4 billion company at 3%. It’s very minimal in terms of what the dilution to organic growth is and obviously we’re trying to drive that growth of the combined company to be even faster.

Daniel Brennan – Morgan Stanley & Co. LLC

Okay. And then in terms of the financial Marc, I know the Company has discussed about issuing, I think a max of maybe $1.75 billion in equity securities for what’s remaining to kind of complete the transaction. By our math, Thermo in the combined entity might have enough free cash flow on hand to actually completely plug that equity hole as opposed to having to coming back to the market. I mean how should we think about what level of cash the Company is comfortable operating with such that maybe that becomes a reality?

Marc N. Casper

Yeah, so when we did the initial announcement in terms of how we’re going to financing the deal, we assume some level of debt from Life Technologies articulated that we take the cash plus raising debt to about a 4.5 times leverage ratio, and then the plug would be the equity portion of that.

We reduced the size of the equity that we’re going to rise when we actually did our first offering of equity, and we raised about $2.5 billion. We feel that the last $750 million make sense. So somewhere in that range, we plan on rising at both the end of the year and feel like that’s appropriate. That reflects the cash on hand and using some portion of that. So I think that’s an assumption in terms of what we’re going to do for the final tranche of financing.

Daniel Brennan – Morgan Stanley & Co. LLC

Okay, any hands of anyone? Okay, but maybe let’s talk about the Life, and maybe let’s talk about a little bit kind of recent results and then we kind of back in some of your customer end market. So I think the Company, Thermo’s done that quite well during the channeling times, putting up consistent strong quarterly performance. I think the most recent quarter kind of notwithstanding maybe one of the few times on the top line, it hasn’t been kind of better than expected after a strong spring of that.

But nonetheless, maybe you can just give us a sense of your kind of full year guidance, given the environment that we’re still in which clearly we’re not out of the woods yet on kind of the macro and U.S. academic kind of your level of confidence conservatism maybe on achieving full year numbers?

Marc N. Casper

Yeah, when we look at the first half and compared to the original guidance that we gave, we felt like we were able to raise the lower end of the guidance to some of the fact that we had a good first half of the year. We don’t give quarterly guidance sort of on the top line. We felt like our performance was at the higher end of the expectation.

So we still feel like we will come in at around 2% organic growth for this year. And given the impact of sequestration and pretty weak industrial markets, we feel like that is reasonable performance for 2013. So we have a high level of confidence, our ability to achieve the guidance that we outlined back in July.

Daniel Brennan – Morgan Stanley & Co. LLC

All right, I mean and then maybe we can kind of even step back a little bit further and I think that there is a bias towards improving global economic growth right now, 70% of your business is more recurring in nature. You still have some exposure to the more I guess industrial and other parts of the economy. So as we sit here today, since you reported the last quarter, I mean are you feeling that, are you seeing kind of any trend towards improving growth whether it would be here or Europe just more globally?

Marc N. Casper

Yeah, so clearly Europe had a strong performance for us in Q2. And it was at a differentiated level versus both last few quarters. So it was too early to call a trend per se, but certainly some that we’re paying attention to. We saw real strong stabilization in Southern Europe.

So that’s the area that’s been on the positive. Clearly, China has been very strong and consistent growing organically for the last couple of years about 20% on a very consistent quarter-to-quarter basis. So that’s been very good and the U.S. has been the area that’s been a little bit weak, which has really been primarily result of sequestration in the government. So that’s where we stand at this point.

Daniel Brennan – Morgan Stanley & Co. LLC

And I know historically the Company, at the Analyst Day, which occurred late in the spring historically used to project that kind of to the forward, and you kind of stop doing that. So I’m just wondering with the headwinds that you’re facing this year from U.S. academic and from some of your industrial business as we look kind of beyond this year, I mean are you in a point yet, where it’s fair to say those headwinds at least become neutralize such as they become additive to the growth right next year?

Marc N. Casper

Yeah, we will give detailed guidance and assumptions. One, when we close Life Technologies transactions; second, when we started at the beginning of the year. So we’ll figure out these at sequencing. When I look at it from where we sit right now, we haven’t seen a reflection on the industrial part of our business yet.

So that’s been a low single-digit decline. And obviously some of the data that we’re reading about as a positive to that, but hasn’t yet translated into our business, biopharma has been very strong, continues to be strong with high single-digit growth.

So the swing factors are going to be kind of GDP related on the industrial side of our business and the second one is will the U.S. government get a budget, right. So if we’re in a continuing resolution environment for all of next year then that would be market conditions or probably slightly weaker than where we are today. And if we get a budget then it would be a little bit stronger than what we saw in 2013.

Daniel Brennan – Morgan Stanley & Co. LLC

In terms of the U.S. economic customer base, I believe it’s maybe about 12% of your revenues or there about with NIH exposure about half or even less than that? And certainly entering the year, there was expected 8% cut to the NIH, but if it got reduced with the last minute deal such that, I’m just wondering as we look forward towards the next fiscal year the government, how should investors be thinking about your kind of U.S. academic business because maybe the cut we see wasn’t as significant and maybe the benefit next year on a relative basis won’t be as great. I’m just kind of wondering on an update of that customer base?

Marc N. Casper

Yeah, generally we haven’t seen big changes in the trends in the academic market right now. It’s been conservative on spending consumables being stronger than capital equipment. So I think right now what those customers are really looking for is some positive signs as well in their own funding environment. So to the extent, the U.S. government gets a budget passed that would be good news, I would say in terms of the funding outlook for those customers.

Daniel Brennan – Morgan Stanley & Co. LLC

Okay. So you alluded to Pharma earlier which has been a really kind of strong hold for you and I have been entering two points. Number one what how can you discuss the benefits if you will of the original Fisher merger, which replaced five plus years ago, is that at all contributing towards the strength that you’re seeing in pharma certainly some of your businesses are clinical trial business, I think the bioprocess production business, those businesses are certainly contributing. But what is enabling to grow up the single-digit in pharma well in excess I think of what a normalized trend line growth would be how sustainable is that?

Marc N. Casper

Yeah it’s an area where when we think about M&A if you’re continuing to get new revenue synergies five years or six years after transaction closes you’ve done a good job in terms of how you’ve integrated and if I think about the combination of Thermo Fisher, we continue to drive share gains because of that combination.

So it’s not that it took years to get it but that it was so compelling that effectively the adoption continues to accelerate. When you look at the bio-pharmaceutical customer set effectively you went from a market where end user preference was the king and the business side of the equation was unimportant to as patent quest started to become relevant driving productivity for innovation was very important to those customers and that shift which really is something we’ve anticipated for the last decade allowed our value proposition to really drive substantial share gains.

And when you get into the details of it effectively our clinical trials logistics business is effectively taking what was in house at pharmaceutical companies and bringing it to us. We are lower cost and we’re certainly higher quality versus the in-house capabilities, our channel business is giving our customers efficiency and choice but managing the complexity of the many thousands of SKUs that you would find and supplying the laboratory and that’s allowed us to gain share and then in our bio-process production business where you’re moving from what was historically is very expensive manufacturing processes where you would have these campaigns of making a drug within a very long sterilization process between campaigns to single use disposables where you can really take inventory down and operating costs down substantially.

We have driven very substantial momentum in driving that conversion of technologies. So it’s a very broad based, we are excited about what our prospects are and we have a very different shade of position, we have many customers that have $50, $100, $100 million plus revenue relationships in the pharmaceutical companies and because of that we have CEO to CEO relationships and that is the opportunity for us to continue to drive share gain and make sure we’re aligned with their business priorities.

Daniel Brennan – Morgan Stanley & Co. LLC

Maybe just connected to that, just in terms of your top pharma customers, just I mean where were you with the rate of Life, do you think you are at like the penetration levels, you done what you needed to do and now you’re going to grow with the company and connected to that I know you had this initiative with the company going after your top customers, particularly in pharma, where does that stand outside of pharma, I know Medtech has been an industry where you’ve also been trying to push that initiative. So just talk a little bit about the real kind of the upside still from that strategy?

Marc N. Casper

Yeah, there is no customer even in bio-pharma that I feel like reached our full entitlement. We have some that we’ve really driven substantial share gain, but still work to be done. But we’ve taken the learnings that we’ve had and we’ve applied it to the contract testing labs, to the clinical reference labs, to the medical tech and petrochemicals. So a number of other customers that are also very focused on productivity have been good opportunities and then in a very targeted ways, we’ve been able to even do some of that at the academic customer side as well. So it’s a little bit of different sales process, but helping labs and department had to deal with driving more efficiency, we have done some targeted work there also.

Daniel Brennan – Morgan Stanley & Co. LLC

And maybe we entitled to kind of little bit of geography before getting into like product development pipeline and kind of profitability. But just in terms of geography certainly China has been amazing run for the company with the consistency of strong growth that you’ve achieved well many of your peers have done quite well that as well but maybe not as consistent, just is there any degradation to that growth rate that you’re feeling today certainly you’re much more exposed on the secular dynamics to China but nonetheless with lot of the economic kind of slowing there, some of the credit issues. How you’re seeing your China business and the sustainability of that growth?

Marc N. Casper

Yeah, from a China perspective the last eight quarters or so, we’ve been growing organically 20% and underneath that has been really quite a soft industrial business. So infrastructure builders is quite soft, so the question is how we’re sustaining the rate and basically what has happened is the recent five year plan the couple of years ago has been very aligned around environmental, food safety and healthcare expansion and those are technologies that we enable.

So we’ve seen huge growth in those markets that have offset a much weaker industrial set of customers and allowed us to sustain 20% growth. When we look going forward the five year plan is set for a few more years, so we feel like the macro drivers aren’t going to change and then you get down to more of your industrial business and there the question is will there be any catalysts to see improvement if there is upside to the numbers and if it continues to be muted then we still feel confident of delivering still very strong growth.

Daniel Brennan – Morgan Stanley & Co. LLC

And certainly emerging markets are a key strategy for almost every U.S. Companies certainly every large company is certainly a top strategy as well for Thermo Fisher just beyond China given emerging market volatility right now maybe a bit of a degradation to growth, what you have seen in some of your bigger emerging markets in terms of whether important trends up or down?

Marc N. Casper

Yeah. So when you look at our emerging markets China by far the most important and China in particular we’ve used our scale to build-out a very differential experience right. So we do R&D locally, we manufacture locally, we have a very substantial supply chain capabilities where customers can get products very quickly and that’s allowed us to gain share when you get to the next tier of importance Russia, Brazil it would be Korea, it would be the next tier of important markets and generally the momentum in those three markets have been very strong.

When you get down to the next tier of kind of the third level it’s going to be kind of kind of India, Middle East, Eastern Europe. Within that group, India has been a little bit impacted recently with the changes in exchange rates on customers’ ability to important products. But it’s really not material to Thermo Fisher. It’s a business that’s less than $200 million in aggregate. So while there is some pressure there, it really doesn’t move the needle in India.

Question-and-Answer Session

Unidentified Analyst

Okay. [Question Inaudible]

Marc N. Casper

Yeah. So the question was that, “China regulatory market has been tough over the last few months in the healthcare, any comments?” So I think you see shifting landscape on regulations in China that clearly allows foreign companies to have to scramble to meet product registration requirements and changes and we too face some of those things.

And we’re very, very focused on complying with all the regulations as they change and we have good government relations with the Chinese government and make sure that we are in active dialogue to understand what the landscape is. So we see a little bit of the headwinds and we’re working through. But we still really enjoyed very strong growth.

Daniel Brennan – Morgan Stanley & Co. LLC

Maybe we can talk a little bit in innovation, Marc. I mean you have nearly $14 billion revenue Company on your own. So often in terms there aren’t specific products that can really move the needle for the Company, but nonetheless you may expect – if not your biggest business and you made a big splash at this year’s recent conference with the new product introduction. Fusion is the big high-end product. It seems to be very innovative and differentiated.

So I’m just wondering thus far that conference in for the sales cycle is necessarily short, but I’m sure you’ve had a lot of introductory customer meetings. Just wondering about the feedback thus far and how we should think about the opportunity in 2014 and 2015 for that product?

Marc N. Casper

Yeah. So when we started out the year, we said that the American Society for Mass Spectrometry conference in June was going to be a very strong one for Thermo Fisher and that turns out to be the case.

We launched three new insurance platforms. The one that you’re referring to is our new research tool called the Orbitrap‎ fibrin and new category of instruments, minimal cannibalization with other products that we make should be $100 million product line for us over time. So a nice growth opportunity for us in terms of just organically developing the business, early feedback has been usually positive, right.

So we’ve been shipping the product and see really nice ramp up. So we feel very good about the prospects. We also launched two triple quadrupole instruments. Those are used for more routine testing, things like environmental testing, food safety, some pharmaceutical testing as well and early feedback there is also possible.

Daniel Brennan – Morgan Stanley & Co. LLC

Okay. So maybe just one more question on the Fusion, I know you’ve talked about $100 million product relative to the Orbi, but you would think possibly given the price tag on that could certainly be something much bigger than that, maybe to seeing replacement opportunity, isn’t as big, but from initial work we have done. Do you think you could see that? Is that the level of natural conservatism or is that how do you come up with that just…?

Marc N. Casper

Yeah, we basically look at the number of customers that are going to be spending $750,000 to $1 million on mass spectrometer and have the ability to get the funding in this environment and feel like that 100-ish customers a year somewhere in that range seems like a reasonable assumption a little more, obviously with the Q exactly, which was the last blockbuster product, which we launched at the end of 2011, thus far eclipse the $100 million price point, there was about $400,000. So we were able to sell a much higher volume of those products and we think $100 million is a good assumption. But we won’t stop there and we’ll keep driving for as much as we can.

Daniel Brennan – Morgan Stanley & Co. LLC

Right, okay. Kind of move over to maybe some financial discussion, I mean the companies had a pretty consistent track record of generating operating leverage parts of the income statement and certainly PPI processes, low core sourcing manufacturing and I think the Company has been confident, talked about that operating margin can go kind of well into the 20s, maybe just give us some update of kind of the visibility and the confidence around squeezing more cost out of the system?

Marc N. Casper

Yeah. So when you look at our business, we basically have over long periods of time, expanded margins at 50 to 100 basis points a year based on delivering the single-digit organic growth. In this environment of the sequestration and weaker industrial environment, we basically targeted 30 to 50 basis points of margin expansion, and that is still offsetting almost 75 basis points of headwind from the Japanese Yen and the medical device tax, which is once reflect this year.

So even at low single-digit-growth we’ve been able to offset 75 basis points and still deliver close to 50 basis points. So we feel like we have a lot of momentum. Going forward, we believe that the ability to get our margins which are about 19.5% today to get them into the mid 20s is an achievable goal, which means that we think we have that 50 to 100 basis points of headwind opportunity a year for the next five years or so.

Daniel Brennan – Morgan Stanley & Co. LLC

Maybe related to that we can circle back to Life for a second, in terms of the PPI process that Thermo has been very successful in kind of your version Six Sigma. Maybe if you could talk a little bit about in your initial analysis or maybe the in-depth analysis you’ve done of Life. Is there an opportunity to apply some of your PPI practice, which has been so successful to the Company over the Life or how far advanced today in their own Six Sigma, I guess maybe better way to ask the question?

Marc N. Casper

Yeah, I think Life Technologies has done a good job on the manufacturing side of applying continuous improved methodologies, where the Company has been less focused and where Thermo Fisher has been very focused as using that same methodology on more of the SG&A side of things, and we think that’s a great opportunity going forward for using continuous improvement in our PPI business system to really drive efficiencies and effectiveness and things like selling, marketing the cash process. Those things were quite process intensive and if you can take a lot of inefficiencies and ways of the system. So what we think that is a good synergy between the two fronts.

Daniel Brennan – Morgan Stanley & Co. LLC

And we might be looking at a little further, but as Life closes and are you begin to execute on the business plan and kind of pay down debt, you begin to have a balance sheet back in 2004 due to capacity to go do things with your free cash again in terms of whether it would be kind of buybacks or even tuck-ins?

How should investors think about the dividends in that context? When you initiated the dividend, it was only last year, right you have a yield and I think somewhere below, a little bit below percent. Is that something now with the higher recurring mix of business, we have a better profitability post Life, maybe a steadier kind of growth franchise that maybe a higher dividend maybe something that you find attractive?

Marc N. Casper

Yeah, from a capital deployment perspective what our plans are obviously as our transaction closed and start delivering aggressively and when we get back to more of the normal leverage targets, Dan as you mentioned, we’ll get back and buy a more return in capital to shareholders.

If it that work today, we probably will have a larger dividend in the mix. I’m still doing repurchases of shares, but probably based on many dialogues with the larger shareholders that increasing the dividend, we think sense. So we’ll take stock of that in 2015 about what makes sense at that point in time and if the preference continues to be to expand the dividend and that’s something we’d be very comfortable there.

Daniel Brennan – Morgan Stanley & Co. LLC

Maybe just thinking about your strategic priorities, certainly Life is got to be front on all the different things that have had between now and closing getting that business kind of integrated with Thermo. But if you think beyond the Life transaction and just kind of Thermo, like what are some of the key strategic initiatives that you are focused on in the back when you manage being focused on over the next few years?

Marc N. Casper

Yeah. So the last question, I guess we’re focused on making innovation really matter for our customers. The combined company will spend through course of doing 1,000 innovations and making sure that we just have incredibly powerful through the policy drive growth.

To have the winning position in emerging markets, the high growth reason to the world and make sure that we continue to build our strong momentum that we have there for the combined company, and then obviously use our unique customer value proposition and drive productivity for our customers and innovation and continue to leverage that to drive share gains for the combined business. So those are the priorities and obviously overarching all of that is to successfully integrate Life Technologies and make sure that we do a great job in building an even stronger industry leader.

Daniel Brennan – Morgan Stanley & Co. LLC

Great. Okay and with that, we’re out of time. So Marc, thank you very much and thank you for your attendance.

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