Avantor, Inc. (AVTR) Earnings Call Transcript & Summary

Hello. Good afternoon, everyone. This is Derik De Bruin, the Bank of America life sciences and diagnostic tools analyst. Welcome to our 2020 Healthcare Conference, Virtual Vegas. I thought about sending around some scratch and sniff cards, so you could get a sense of the cheap perfume and cigarettes, but they didn't have that in the budget. So to kick off our next session, it's our pleasure to have Avantor. With us today from Avantor is Mike Stubblefield, President and CEO; and Tom Szlosek, Executive Vice President and CFO. Gentlemen, welcome to Virtual Vegas. Thanks for being here today.

Yes, thanks, Derik. Happy to be with you as well. Thanks for hosting this.

Great. So it's been -- I mean it's hard to believe, but it's been a year since Avantor's IPO. I think even though many clients are familiar with VWR, the side of the business, I still think the legacy Avantor side still holds a little bit of a mystery to people. So I guess to set the stage, can you sort of talk about a brief overview of the combined business and then sort of -- and why it's stronger than any of your components?

Yes. I think that's a great place to start, Derik. And obviously, it has been a busy year. And certainly, as we sat here a year ago, I hadn't foreseen the circumstances that we find ourselves in today and hope that everybody is indeed healthy and safe. When we look at what the business is today, we're really set out to build an integrated leader in the life sciences industry that would combine the legacy Avantor strength in -- especially in the biopharma production space, together with the legacy VWR channel reach into labs across the world that, then on a combined basis, would enable us to provide significant content across all the workflows that our customers would be executing, starting in early-phase discovery and development in the R&D labs and then being able to support them as they work through the trialing and development phases and ultimately achieve commercialization at scale with their approved therapies. And we're combining a lot of technology and product capability in the form of legacy Avantor with a really broad offering that would cover almost the end-to-end workflow in the bioproduction space, providing lots of process ingredients and media supplements, buffers, chromatography solutions, high-purity chemicals, excipients, single-use solutions that really make us relevant to our customers in the biopharma space. So it's been a fantastic combination that, in a unique way, has accelerated the growth of both businesses. The combination allowed us to extend our reach that -- where we were strong in production, to extend that into the lab, get access to more platforms, expose our materials to more scientists and ultimately grow the size of our pipeline. On the other side of the equation, by being able to bring more proprietary content and to be able to provide our customers now an integrated experience end-to-end, we've also seen an uptick in the growth of our business in the laboratory environment. We obviously have a mix of business here. Roughly 50% of our revenue comes from our own branded products and technologies and roughly 50% comes from the brands and products of our third-party supplier partners, and that's an important part of our business model. And I think if you look at the benefits of the new Avantor here, we've been able to extend the reach and market access and value that we offer to our supplier partners, and certainly, they're an important element of our overall value proposition. And then ultimately, with an eye towards increasing value to our customers, we've been able to enhance our supply chain, improve our service levels and ultimately provide a broader and more compelling offering to our customers. And we see that being reflected in the growth of the combined company.

Great. That's a good introduction to the business. I want to hit a couple of controversial points first. The stock took a significant hit in March, declining far more than your life sciences peers. I think the 2 factors driving that decline were concerns over your industrial/macro exposure and your higher net leverage relative to your peers. Can we address these points right now? I guess how cyclical is Avantor today? And how should we think about your ability to grow through recession?

So one of the things that we like most about our business here is its resilience. 85% of our revenue is recurring. We have a very broad product portfolio, more than 6 million SKUs. We're not overreliant on any single product category. Our largest customer represents less than 3% of our revenue. More than half of our revenue comes from the biopharma space and the attractive growth it's offered not only in the lab but certainly in the production space. And I think when you look at all those factors, the business does perform reasonably well across most economic cycles. If you look back at the '08, '09 downturn, the business performed pretty well. And I think the key here being the lack of exposure to capital procurement spend cycles with less than 15% of our revenue coming from that area. That's the category that gets hit the hardest in times like we see back in '08, '09 and certainly times like we see now. So the business is quite resilient. It's capital-light. We spend 1% to 2% of our revenue on capital. And I think that the business generates a lot of cash, and you see that in its ability to grow cash flow over time. And certainly, our Q1 results are a good benchmark for the cash flow capability. [Audio Gap] Probably 25% of our business is in the applied markets. And as we look at that space, that's a collection of a number of end markets and application areas, no single one, probably more than 2% or 3% in total, and as we look at the growth and the revenue profile of the markets that we serve there, probably half of that platform would exhibit what I would consider kind of defensive growth-oriented characteristics, meaning pretty insulated from macro factors and end markets like the defense market, would be an example of that. And then certainly probably half of that platform representing maybe 10% to 12% of our overall revenue would indeed fit more of a cyclical industrial definition following PMIs and GDP growth around the world. And that's going to cover things like oil and gas and petchem. So if you look at an environment like we find ourselves in now, there are certainly -- the end markets that would fall within that bucket certainly are off considerably high single digits, low double-digit-type levels. While the other part of our applied markets, food and beverage, our semiconductor exposure, our defense exposure, now you see actually growth coming through even in an environment like we say -- that we see here. So I think part of that, as you mentioned, we're relatively a new issuance, less than a year on the public markets, and there's a bit of education. I think that's important and for people to get familiar with what we have in the business. I think we -- when you unpack it, there's certainly less industrial exposure here than what might be -- what people might think. And you see that in the performance across cycles. The business did well in the '08, '09 downturn. I think if you look at our Q1 numbers and our results from April, I think that further makes that point.

Yes. I mean we'll get to the near term -- yes. I was going there next. Yes, yes.

Yes. So that's an important area to also understand. Obviously, when we put the deal together back in 2017, we had to get a little bit creative in how we financed the deal. But the business has delevered relatively quickly, owing to the -- both the growth in the business, the execution that the team's been able to deliver and the strong cash flow generation, together with the IPO that you referenced from a year ago. So as we sit here today, on the back end of the first quarter, leverage was at 4.4x, it's been deleveraging organically at, call it, 1/4, 2/10 to 1/4 turn a quarter. So we're certainly on track to be sub-4x, which is our target here later this year. The covenant -- or the debt structure itself is pretty attractive. We don't have any maturities until -- no meaningful maturities until 2024, pretty covenant-light structure. And if you look at the revolvers that we have in place together with our cash, we have more than $800 million of liquidity available to us, certainly more than enough to run the business today. And as we have stress tested the business in all kinds of downside scenarios associated with the pandemic, we're pretty comfortable with where we're at here.

Great. Good answer. Basically, for most of March and February, March, that's essentially every conversation I had with investors, was along those lines. Speaking of it, I mean, you took a bigger hit in March, but you also had much bigger gains following your second quarter results, which were much better than people expected. I mean can we just sort of talk about areas of strength and weakness in the end markets? And you've mentioned, obviously, some strength in bioprocessing and biopharma. Can we just sort of walk that up and sort of like how you -- now you're positioned going into 2Q and the rest of the year?

If you look at Q1, it printed just a tick above 4% on an organic basis. And that was against our toughest prior year comparison last year, which was around 8%. And I think it gave us a good opportunity here to really demonstrate the resilience of the business model and the value of having as much of our revenue, 85%, that's recurring and limited exposure to the capital procurement cycles. I think it also demonstrated the value of our end-market exposure with roughly 2/3 of our revenue in the life sciences area highlighted and headlined by our biopharma exposure. 50% of our business is going to be in that space, and we're going to cover the workflows starting in the lab. Roughly 2/3 of our biopharma revenue is going to be R&D-driven, and roughly 1/3 of it as -- is going to be in the production space. And on a combined basis, we have half of our revenue now growing kind of high single digits in the first quarter here that really provides a nice tailwind and backdrop for growth. If you look at some of the other end markets, the health care market for us is roughly 10% of our revenue. Split pretty equally, maybe half of that is going to be clinical diagnostic-driven, and roughly half of that is going to be our high-purity silicone implant business. And certainly, that platform is performing well through most of the quarter, did start to see some headwinds come in, in March as the virus spread from east to west. And you started to see the impact, both in Europe as well as in the Americas, on elective procedures that impacted kind of both ends of that end market. We were able to somewhat offset those headwinds with a significant pickup in COVID-related diagnostic workflows that we're supporting. We can go into what we do there here in a bit, perhaps. And then as you look at that, those 2 end markets going into the second quarter, continued strong momentum through April in biopharma, again, high single digits, headlined by mid-teens to upper teens growth in bioproduction. The health care piece you see in moving into the second quarter, the full brunt of the headwinds associated with elective procedures, and so you see that part of the business down modestly in the month of April. But the biggest headwind that we faced moving from March into April is certainly in the academic and government space. Roughly 10% of our revenue is associated with the academic world, particularly the university-driven research work. And that really started to slow down in the middle of March, and then it pretty well had leveled off at the levels that we see today by early April, which is to say that platform's probably off 40% to 50%, in line with the number of labs around the world that are either completely shut down or at least partially shut down. And fortunately for us, that only represents about 10% of the business. But clearly, without question, that's the biggest headwind that we face in the business today. There's about 5% government exposure, and that's been hanging in there at kind of mid- to high single-digit levels for most of the year here. We are benefiting from some of the United Nations-type aid programs and things that we're participating in associated with COVID. So that's been able to provide somewhat of an offset to some of the headwinds that we face in the academic world. But net-net, we're down pretty significantly in the education & government part of our business. And then the last part of our business is the applied markets that I referenced earlier, roughly 25%, and that grew low single digits in Q1. Moving sequentially from March to April, we did see some additional headwinds come into play, particularly in the industrial part of that business, which, to reinforce, is about roughly 10% of the total revenue as oil and gas prices really started to collapse. And you saw the full impact of production curtailments and a dramatic drop in demand in that part of the business, so moving from -- in Q1 from low single digits to something that's probably flattish to down low single digits in that range for that part of the portfolio in the month of April.

Got it. So I guess, what is sort of your scenario on how do you think about labs reopening? What are you -- what's your sort of like base case scenario? And then, I guess, the other -- the flip side of that is that if there is a second wave of infection later this year, then, I guess, relative to what you've seen with the initial outbreak and shutdowns, how do you think that could impact your business?

All right. So I mean, clearly, there is that risk, which is -- and it's -- we don't have a crystal ball here to know what the recovery curve is going to look like and whether there's a relapse or not, which is ultimately why we pulled our full year guidance. But if you focus on a scenario that we kind of find ourselves in today, which is kind of a phased reopening around the world, right, you see Asia, for the most part, it's nearing -- getting close to kind of business as usual in most of the markets we operate in. India's probably a bit of an outlier still as they're still under their lockdown orders and things are still a little bit difficult to move around there. But generally, in Singapore and Korea, China, we're seeing more normalized demand levels. You're starting to see some reopenings in Europe. It's early days, obviously. I think that probably started yesterday, and we'll see how that goes. And then in the U.S., you obviously have a number of states that are either starting to reopen or nearing to look at getting back to work. And those are all providing a helpful backdrop for getting the researchers back into the lab. And we think in that, if you were to follow that curve out, we think the research business should roughly follow that curve. We're obviously staying very close to it. And as we talk to the institutions that we support and engage with, I think it's pretty clear that there -- many, if not all, of these institutions are making plans to reopen broadly across the campus. And with very few exceptions, it seems that the researchers returning to the lab would be part of kind of any Phase 1 campus reopening and in most cases, even before students come back. These -- the research these scientists are doing are important sources of revenue for the university. They're kind of independently funded. Many of them are associated with grants or contracts that are industry funded. And so I think there is a strong push to try to reopen these as soon as possible, obviously, in a responsible way. And we're certainly working with many of these labs to put in place a restart plan. So I wouldn't say that as we sit here in the early days of May that we've seen a big wave of restarts yet. But we're encouraged by the amount of activity and planning that we see going on. And I think as we move through the month of April without any flare-ups or relapse here, we would expect to start to see some of these labs come back online. And then I think our expectation in that scenario would be for even more of these to start coming back online through June and July. Relative to what happens in a relapse, probably difficult to speculate on exactly does it go back to what it looked like in March, does it -- with testing, are we able to isolate and take actions and measures on a more calculated, localized basis. That would be our -- certainly our hope that just given the availability of testing and having contact tracing in place, these kinds of measures, that we would be able to, as a society, isolate any of the hotspots and just deal with those as opposed to having to shut down the entire economy. But obviously, we don't exactly know, and we'll be watching that as closely as anybody.

Right. Right. I mean you briefly mentioned it, but you are a supplier to diagnostic companies doing products for COVID-19 testing. Can you sort of elaborate on your exposure to that market?

Yes. So if you look at the health care end market that we serve, it's roughly 10% of our revenue. And as I mentioned, roughly half of that is going to be clinical diagnostic-driven, supplying a lot of content into the reference labs that would be supporting clinics and hospitals and point-of-care facilities. In the -- as that model has ramped down as the hospital and the health care networks have tried to preserve capacity to treat COVID patients, we've seen a significant ramp-up in the demand for our materials and components that are used to support COVID testing. I think at this point, most people are familiar with the 2 types of tests that are out there. You have the PCR-based tests, where the sample preparation component of that test is pretty significant. You're talking about RNA and DNA extraction kits and PCR reagents and a lot of consumables that we're going to be supplying that have been -- it's certainly helpful to us in offsetting some of the headwinds that we face on the clinical diagnostics side. We also are going to be supplying the serological test kits into the market. We've partnered with some OEMs and would be bringing those kits in through our channel into the health care system as well as we would be supporting some of the OEM producers with certain chemicals and ingredients that are being used in their manufacture of those kits. So the third place then that we would play in that testing environment, you may know that we have a services platform that is involved in custom-kitting to support clinical trials and have been able to pivot a big part of that business to actually get involved in the production and assembly and distribution of the PCR-based COVID-19 tests into the laboratory network. And that's certainly driven a significant amount of demand for us as we've moved through the early stages of April, now into May. So pretty relevant from a testing standpoint. And as you would expect, given our exposure to biopharma, we're also very relevant to the vaccine and therapy development space and are engaged deeply with a number of the leading solutions and are working side-by-side with our customers in the race for a cure. There's obviously a pretty deep pipeline of therapies and vaccines that are being developed, more than 170 by the last count that I had that are biologics-driven. And most of those are going to be monoclonal antibodies, which obviously are right in our sweet spot. You see mRNA technologies and vaccines, cell and gene therapy solutions that, again, are going to be pretty relevant for our portfolio. So we're busy partnering with our customers to get them materials and make the breadth of our capabilities and process development expertise available to help accelerate the development of a cure. So from that standpoint, this has been a pretty exciting time for our team and certainly, a reinforcement of not only do we have great reach and access to the life sciences market broadly, but we're extremely relevant in the content that we provide to enable a lot of the solutions that are needed at this time.

Great. I want to sneak in a couple of questions on sort of like how you think about margin expansion going forward. And how do you invest -- how do you balance your investing with deleveraging? How much do you spend on R&D? And just sort of let's think about the margin trajectory. Certainly, I think that the 2019 margins came in a little bit lower than we were thinking. So how do we think about the margin's progression from here?

Yes. I'll talk a little bit about, I think, where we're at from an R&D standpoint, and then -- and maybe Tom can touch on the margin expansion algorithm. Innovation for us is critical. It's critical for our customers, and they expect us to be able to bring new solutions and capabilities to bear. And this COVID situation is a great example of the importance of that. I think you'll know that we've been investing steadily here in the infrastructure to allow us to have the capabilities to be able to innovate and do it in a customer-centric way. And our model is to put these application and technology development centers close to our customers. So I think we're up to 9 now. We most recently inaugurated a center in Shanghai. And we just, earlier this year, doubled the size of our flagship center in the U.S. to support our cell and gene therapy work that we're doing. So innovation and new product introduction is really critical for us, especially for our own technologies. And we're going to be overweighting the investment in solutions for the bioproduction area. You would have obviously seen highlighted in our first quarter release our recent launch of PROchievA, which is our new protein A chromatography resin that we're really excited about that we've been developing over the last 3 or 4 years. We're going to be investing to support our high-purity silicone platform, and we would be investing to support next-generation technologies in the semiconductor space. Those are probably, from a proprietary technology standpoint, probably the areas of emphasis for us. Importantly, we're also an important channel for our customers' innovations. And so when we look at innovation, we're going to look at it holistically and on a monthly basis. We're going to be looking at the number of new product introductions coming out of our R&D pipeline as well as the number of new product launches coming from our third-party suppliers. And I think if you were to look at the investment that we're making on R&D on our own technologies relative to the revenue that those specific businesses that we're funding are generating, you would see us spending in that kind of mid-single-digit level as a percentage of revenue, which I think is very much in line for a material-centric business like ours, where development is probably more of an emphasis than first principle's primary research. That's how we think about R&D. Tom, you want to elaborate on kind of the margin expansion algorithm?

Yes, absolutely. I mean just going back to 2018 and '19, I mean, expansion has been pretty impressive, over 200 basis points in '18 and close to 100 basis points in 2019. And we gave guidance for 2020 before we withdrew guidance. So it wasn't quite at the triple-digit levels, but we do have a pretty good playbook going there. I mean it starts with growth. And if we can continue to be a mid-single-digit-plus grower, we're going to get fixed cost leverage. We have a fair amount of fixed cost throughout the system, including our manufacturing footprint, including our distribution footprint and including SG&A costs. And generally speaking, if we can manage those well, we should get leverage and do get leverage. Second thing is when you look at how the business commercially manages inflation and pricing, particularly on the COGS side, it is pretty scientific. We take advantage of ensuring that from a transactional perspective, we know and understand where inflation is emerging from our third-party suppliers that we distribute for and making sure that we're pricing accordingly to preserve and generally improve the margin rates. The other aspect of that is on the production side, we do find ourselves in annual -- or long-term contracts that allow for annual repricing depending upon the circumstances. And given the amount of innovation and application development we put into those, we find ourselves having -- being in a pretty strong position from a pricing perspective. So overall, I've been really impressed, my time with Avantor, in terms of how this -- the pricing is managed relative to the value and then the COGS inflation. The third thing is productivity. It's been driven in the last 2.5 years by the integration of VWR into Avantor. And taking advantage of both the cost and commercial synergies, there's a pool of $300 million identified in -- at the outset of the acquisition. We -- our schedules had us completing the integration by the end of 2020 and achieving the $300 million in synergies. We're at a run rate now of $300 million. At end of the first quarter, we basically achieved that. So 2/3 of it came in the form of cost synergies. 1/3 of it came in the form of commercial synergies. We still think there's plenty more to go. And we're embarking on ensuring that we have continuity beyond this -- the integration to drive productivity, particularly in our fixed costs where you don't have that opportunity from a pricing perspective. And so we've got a playbook in place to ensure that we are at least covering the cost of our inflation that occurs, and we're pretty well-equipped to do that. We've -- we have built a significant presence in low-cost regions, where we have centers of excellence that run the gamut of all the way from customer interaction and pricing analysis and -- or configuration, all the way into the back-office things like paying payables and collecting cash and doing some of the accounting. And we have more opportunity to expand that. So we have a number of enablers that help us with the margin expansion. And then the last thing I would mention, Derik, is that the mix has been working in our favor when we grow proprietary offerings like we have. And it's not to say that we're not trying to grow third-party offerings. We clearly are trying to do both. But you tend to have a little bit more of a margin benefit. If you have growth, it's greater on the proprietary side. And so that -- when that comes through, your mix benefits work well. In this particular environment that we're in right now, as Michael described early on, equipment and instrumentation has been challenged with all the closures and the focus on capital budgets. And that's roughly 15% of our business. And it's the lower-margin parts of our business. We don't have a significant proprietary offering on the equipment and instrumentation side. So that tends to give you an extra boost in these times when you're looking at margins as you're mixing more towards nonequipment and instrumentation. So all of those -- all that said, that should drive strong EBITDA growth. And we should be able to drive the EBITDA growth at a multiple of sales, I would say, somewhere between 1.5 and 2x the sales growth rate. Again, depending upon that mix, we should be able to deliver in EBITDA growth, EBITDA dollar growth. And that translates into some of the margin expansion that we've talked about.

Great. We're out of time. So with that, gentlemen, thank you very much for participating. Clients, thank you for listening. And everybody, stay safe, and we'll talk to you soon. Thanks.

Thanks, Derik.

Thanks, Derik.