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Insight & Intelligence™ : Aug 5, 2014

Tool Companies Gain as U.S. Basic Research Revives

Signs of improvement in U.S. research funding appears to be behind the revival.
  • Alex Philippidis

Three biotech tools companies are crediting revived demand among U.S. academic and government labs, among other basic research customers, for their strong results during the second quarter.

Sigma-Aldrich finished Q2 with a new quarterly record of $701 million in sales, up 3% from the second quarter of 2013, and net income of $133 million, up 12% from a year earlier.

Sales for the company’s research business unit inched up 1.1% over Q2 2013, to $357 million. While research sales dipped 0.6% from Q1, Sigma-Aldrich president and CEO Rakesh Sachdev told analysts U.S. research sales rose 4% quarter-over-quarter. The U.S. results—plus strong sales in northern and eastern Europe and China—made up for weak demand among customers in southern Europe, India, South Korea, and Oceania.

U.S. research sales growth was driven by what the company called a “low- to mid-single digit” uptick from last year in sales to research dealers and “robust” sales to biotechs stepping up R&D activity enough to keep sales flat. And while sales to U.S. academic and government institutions was still below a year ago, the rate of decline was only “low-single digit,” Sachdev said, following a surge of buyers late in the second quarter.

“We were encouraged to see U.S. academic sales improved as the quarter progressed,” Sachdev said July 24 on his company’s quarterly earnings conference call. “While some of the sequential improvement was caused by Q1 weather, we also saw increased demand from U.S. academic and NIH researchers.”

As a result, Sachdev said, “The U.S. funding environment is showing some signs of improvement, and we are cautiously optimistic that this gradual pace of improvement will continue through the balance of the year.”

Lower Expectations

Analysts with two firms are showing less optimism than Sachdev, with Michael Waterhouse, equity analyst with Morningstar, telling GEN: “Our expectations remain low.”

“The research spending side looks bleak, and we don’t foresee a meaningful uptick anytime soon,” Waterhouse said. “I’d be surprised to see anything beyond inflation in the academic/government segment for a while. But it’s always possible Sigma can squeeze out some higher incremental growth through higher value products or services.”

If that happens, Waterhouse said, it may be because of something Sachdev noted during the conference call: The company’s SAFC Commercial unit results were lower than expected in Q2 due to delays in large customer orders from contract research organizations, which the CEO said are expected to boost results in the fourth quarter and into 2015.

The investment firm Jefferies said Sigma’s forecast for 4% research growth in the second half appears easier said than done.

“Notwithstanding [Sigma]’s solid track record of execution, overcapitalized status, and strong [return on invested capital] ROIC profile, its secular organic revenue growth goals may be increasingly challenging to achieve in a more cost-conscious environment for pharmaceutical companies,” Jefferies equity analyst Brandon Couillard and equity associates Sachin Kulkarni and Kate Blanton stated in a July 24 report to investors.

Illumina finished the second quarter with $47 million in net income, up 31% from Q2 2013, on revenue that rose 29% to $448 million. The company raised its guidance to investors on revenues and adjusted earnings per share.

Like Sigma, Illumina cited improving prospects for research customers, citing the 3% budget increase for NIH during federal fiscal year 2014, which ends September 30: “We believe that allocations within the NIH budget will continue to favor genetic analysis tools generally and, in particular, research programs that utilize next-generation sequencing.”

Broadening the Base

At the same time, Illumina says it is broadening its customer base to make itself less dependent on NIH-funded customers in academia and government.

“We estimate that less than 30% of our total revenue in 2013 came from academic or government customers in the United States” that directly or indirectly rely on NIH funds, the company stated in its Form 10-Q quarterly filing with the U.S. Securities and Exchange Commission. “Approximately 45% of our total revenue came from customers who are not directly reliant on government agencies for funding.”

A growing number of those customers are clinical practices, to which Illumina is devoting increasing attention. Illumina is also focusing more on winning premarket approvals (PMAs) for new equipment for that setting. In July, it acquired Myraqa, a consulting firm specializing in companion diagnostics and other IVDs, for an undisclosed price. Illumina said Myraqa’s regulatory expertise will strengthen its in-house capabilities to expand genomic technology into the clinic while preparing it for the next phase of growth.

“The FDA only approves two to three PMAs a year. And we’re going to try to push a whole bunch of products through there in the next three years,” Illumina CEO Jay Flatley told investors on his company’s July 24 quarterly earnings call. “The strategy is to get these through the FDA, get them approved, and then sell a bundled solution that includes the kit, the software, the instrument, the analytics, the cloud support that’s necessary to implement this, [and] in some cases, data sharing.”

Going with the Flow

Thermo Fisher Scientific blamed charges related to its acquisition of Life Technologies, completed in February, for reporting just a 0.4% increase in net income, to $278.5 million on revenue that jumped 33%, to more than $4.3 billion. Absent those charges, the company said, its adjusted operating income rose 48% to $923.6 million in Q2, its first full quarter as a combined company.

“We believe this quarterly performance should boost confidence in the outlook for continued operational upside over the next several quarters,” Cowen & Co. concluded in a report by the firm’s Doug Schenkel, Shaun Rodriguez, Ph.D., and Chris Lin.

Thermo Fisher president and CEO Marc N. Casper said one reason why quarterly revenue growth improved from the first quarter was stronger academic and government sales.

“In the academic and government end market, we saw improvement in Q2 with growth in the low single digits. We said last quarter that we thought funds would begin to flow in the U.S. under the new [NIH] appropriations. And that seems to be playing out,” Casper told analysts July 23 on the company’s earnings conference call.

In its 10-Q filing, Thermo Fisher blamed weaker Q1 academic and government sales on fewer days worked by those customers due to severe winter weather in much of the nation.

Thermo Fisher said its biopharma services unit capitalized on continued demand for outsourcing and for products across each segment, including lab equipment and lab consumables.

“Stronger results in pharma and biotech led to a first half that played out a bit better than we expected. As a result, we’ve slightly increased our growth outlook for the full-year,” Casper said. In addition to raising its guidance and revenues and adjusted earnings per share, as the Cowen analysts noted, management also raised its guidance for 2014 biopharma activity to “medium- to high-single digit” growth.

Thermo Fisher anticipates drawing more research customers in coming months through new products and services. At the 62nd American Society for Mass Spectrometry (ASMS) Conference on Mass Spectrometry and Allied Topics, Thermo Fisher launched several new products—including the Q Exactive HF liquid chromatography-mass spectrometry (LC-MS) system; PepFinder 1.0 peptide mapping software; and Proteome Discoverer 2.0 software. “Application-specific software is critical to extending the use of mass spec and creating new market opportunities,” Casper said.

While new offerings are likely to draw customers, Thermo Fisher and other biotech tools companies also have to hope for continued improvement in the research environment of the U.S., since it remains the world’s largest biopharma market. U.S. performance in Q2 balanced out slower-than-planned growth elsewhere: Sigma noted softer Indian sales as research customers waited to see what the new prime minister would do. Thermo Fisher cited China’s central government slowing down spending—though the company expects its China sales will rebound in the second half because Q2 bookings remained high. That and other expectations about research markets will be put to the test in coming weeks.