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

Hi, everyone. This is Rachel Vatnsdal from the Life Science Tools and Diagnostics team here at JPMorgan. Today, I'm joined by Michael Stubblefield and Tom Szlosek, CEO and CFO of Avantor. So today, this will be -- the first part will be presentation. The second half will be Q&A-based. We have mic runners throughout the room. So you either can ask a question in person. Or for those of you listening live on the webcast online, you can submit Q&A through the portal. Michael, with that, why don't you take it off?

Excellent. Thank you, Rachel, and good morning, everyone. It's really great to be back here in San Francisco to kick off a new year with all the sunny weather that we're enjoying here in town. But certainly appreciate you joining us for our presentation today. As Rachel mentioned, I'm joined on the stand here by Tom Szlosek, our CFO; and Christina Jones, our Vice President of Investor Relations is here with us as well. Following my remarks today, Tom and I will be happy to take your questions. Before we get started, though, I wanted to summarize a couple of important points from the disclaimer shown here on Slide 2. In my presentation and in the Q&A that follows, we'll be providing forward-looking statements that reflect our current views, but are not guarantees of future performance. Also, our presentation does include some non-GAAP measures, and a reconciliation of these non-GAAP measures is included in the appendix to the presentation. So let's get started on Slide 3. As you've heard us talk about from the beginning, at Avantor, everything that we do is tied to our mission of setting science in motion to create a better world. And we're extremely proud of the role that we play in enabling scientific breakthroughs. Our integrated business model is grounded in supporting our customers from discovery to delivery. And uniquely, we're embedded in virtually every stage of our customers' most important research, scale-up and manufacturing activities that they do perform. Now as with the turn of the calendar, it's natural to do a bit of reflection on the year that just passed. And certainly, as I reflect on 2022, by any measure, it was certainly a dynamic year. But I'm pleased with the strength and resilience exhibited by our core business, especially in biopharma as well as another year of strong margin performance and deleveraging. The macro environment has certainly been more challenging than we had anticipated. And as we commented in the fourth quarter, we do anticipate some of these headwinds persisting with us into 2023, including the roll-off of the COVID-related revenues that we've enjoyed over the last couple of years, ongoing currency headwinds as well as continued consumables destocking. We're looking forward to sharing our fourth quarter and full year results as well as our formal 2023 guidance at our earnings call that's scheduled for February 3. Today, I'm excited to have the opportunity to talk to you about our leading business model and the key growth drivers that will yield strong performance in 2023 and well beyond. Let me start by emphasizing a few critical elements of our model that are highlighted here on Page 4. Notably, more than 85% of our revenue is recurring, enabling a resilient business that has proven to perform well across economic cycles. Importantly, over 70% of our revenue is earned in life science applications with strong secular growth drivers. And we've made great progress towards our 2025 goal of having more than 60% of our revenue derived from proprietary branded products and services that are supplemented by innovative third-party offerings from our critical supplier partners. As shown on Slide 4, Avantor serves attractive high-growth end markets. These 4 end markets have common characteristics, including high regulatory oversight and complex development processes. And we realized significant operational synergies by serving them with a common product portfolio as well as significant shared supply chain infrastructure. Starting with the largest of our 4 end markets in biopharma. We serve as a one-stop shop to support our customers' R&D efforts. And we're a leading manufacturer of custom materials and single-use solutions for the high-growth bioproduction workflows that are critical to this area. Now we're certainly aware of the current debates about the health and strength of the bioprocessing space. But as we look ahead into the -- in 2023, we're certainly confident in the setup as we approach this new year, driven by strong fundamental demand across legacy monoclonal antibody therapies as well as the demand for new therapies and a healthy pipeline of candidates across all modalities, including monoclonals, cell and gene therapy and mRNA. Moving counterclockwise here. Our health care offering supports critical diagnostic workflows as well as we supply in a rather unique way enabling content for implantable medical devices. We also provide precise, reliable research products for the laboratory environment in education and government settings. And we serve research and production applications for some of the world's most demanding environments within our advanced technologies and advanced materials end market. Now importantly, collectively, these 4 end markets represent a total addressable market of more than $80 billion and enable our mid-single-digit plus organic revenue algorithm. Perhaps more importantly, across all of these end markets, we are helping accelerate science in serving patients and customers and the communities around the world. As we move to Slide 5, I wanted to highlight the unique way that we serve these 4 end markets. We essentially do 2 very distinct things for these customers in these end markets. First, shown here on the left-hand side of the slide, we provide comprehensive products and services that enable our laboratory customers to achieve precise analytical results. And that's true whether it's a research or a diagnostic or a quality assurance or a quality control workflow. Now our offering into this space would include products such as ultra high-purity chemicals, high-precision consumables, equipment and instrumentation and a variety of on-site services, including inventory management, bioreactor setup or even media preparation. On the right-hand side of the slide, you see the other thing that we do for our customers. We provide customized materials produced to exacting specifications for our customers' commercialized platforms. Now this would include our leading position with process ingredients, excipients and single-use solutions for the bioprocessing space, but it would also include our high-purity custom silicone formulation platform for medical applications. Now Slide 6 shows what sets us apart and highlights our differentiated value proposition. We have a unique set of capabilities which supports our customers' journey throughout the scientific process. I think one of the hallmarks of our platform is that we are with our customer every step of the way. Our portfolio includes over 6 million SKUs that support the research and production applications that I've described as well as the innovative proprietary content in the third-party offerings that we include in our portfolio. We have a very robust and vast global network of infrastructure that includes more than 30 manufacturing sites, more than 50 distribution centers and more than 13 innovation centers that help us to deliver to customer locations around the world. Empowering our network are our broad team of material scientists and process engineers and quality and regulatory experts that support our customer-centric innovation model. At the heart of the model is our more than 3,700 sales professionals that give us unparalleled customer access to more than 300,000 customer locations in more than 180 countries around the world. Now this differentiated value proposition ultimately translates and enables us to keep life-changing science moving forward and supports our long-term financial algorithm that we've talked about for a couple of years. And Slide 7 summarizes the key elements of this algorithm, specifically, 4% to 6% organic growth, 50 to 100 basis points of annual margin expansion, mid-teens plus adjusted EPS growth and significant capital allocation flexibility. Now these elements of our financial algorithm are underpinned by our Avantor Business System, which drives operational rigor and execution throughout our business. ABS, as we refer to it, provides our associates a common framework for growth and productivity as well as leadership. And at its core, it emphasizes database decision-making, process rigor and problem solving, and it ultimately is a core element of our culture. Now moving to Slide 8, you can see that we have a proven track record of performance. And since our IPO in 2019, we've outperformed our long-term financial algorithm on all metrics, including delivering 6.5% organic revenue CAGR, 130 basis points per year of average margin expansion, 37% CAGR in adjusted net income, and we've expanded free cash flow by 2.5x. Now as we've flagged some headwinds that we will incorporate into our formal 2023 guidance, we certainly don't view any of them as structural, and we maintain our confidence that this financial algorithm holds up well over the long term. Moving to Slide 9. Importantly, our strong financial performance has enabled us to significantly strengthen our balance sheet and created significant flexibility for us. As you can see on the chart on the left, we've reduced net leverage from over 7x to the mid-3s. We've cut interest expense in half, and we reduced our cost of debt to approximately 4%. In the near term, as we've talked about here recently, deleveraging remains our top priority as we look to preserve long-term capital flexibility as well as our efforts to try to manage interest expense for 2023 in a similar range as we've realized in 2022 despite the rising rate environment that we're operating in. Now we've talked a lot over the last several years about the rationale for the transformation we've driven and the combined platform that we have built. And as I look back over the last 4 or 5 years on how that strategy has played out, I wanted to highlight what I think are some of the important aspects of this evolution that have ultimately yielded a much stronger, more resilient and more relevant platform than ever before. Over the last several years, we've nearly doubled the growth rate of our laboratory platform by leveraging our integrated offering, our commitment to innovation, our investments in our supply chain and digital capabilities and our focus on commercial excellence. Now one of the key drivers of the combination with VWR was to leverage the customer access that they brought to give us broader exposure to the important bio production customer landscape. And you can see here on the chart that we've successfully leveraged this access and have driven a more than fourfold increase in the number of bioproduction customers that we serve today compared to a few years ago, which enables us to strategically canvass really the entirety of the market and positions us and enables us to position our leading portfolio in this important growth driver of our business. It certainly translated into an increase in our exposure and our relevance across the key biologic therapies that are in the market today. And as I look into 2023 for our bioproduction platform, I think we're in a position to deliver another year of double-digit core organic revenue growth. Now importantly, as part of our growth journey, we've also invested significantly in our Science for Goodness sustainability platform. We certainly recognize the role that Avantor plays in the life sciences ecosystem and remain committed to continuously improving the way that we embed environmental, social and governance practices into our business. And we made significant progress in 2022. We increased our scores across 4 major rating agencies, and we're on pace to exceed our 2025 target of decreasing greenhouse gas emissions. Now we're currently working on -- we're actively working to accelerate our climate-related commitments in alignment with the latest science. But we know there's much more work to do. And with our spirit of continuous improvement, we're holding ourselves accountable to expand on the progress that we've made, and you should expect to hear more from us on this important topic throughout the year and beyond. Now as we look ahead, we're confident that our business is well positioned for continued growth. And our growth strategy, as you can see on the slide here, is driven by 3 levers: customer-centric innovation, ongoing expansion investments and M&A to augment our proprietary offerings. Let me touch on each of these in a bit more detail over the next few slides. Our innovation model is rooted in our deep customer access, which gives us the opportunity to work with researchers across all industries and geographies and gives us a unique perspective into emerging trends and scientific needs. We collaborate with customers at 13 global innovation centers, including our flagship center in New Jersey as well as our newest location in Shanghai to solve complex material challenges. This generates a meaningful innovation pipeline, which includes more than 1,500 active development projects, and each one of these projects supports a very specific customer driven development opportunity that enables us to work side-by-side with our customers' research and development teams. Now to support the pipeline in 2022, we invested mid-single digits in innovation as a percentage of our self-manufactured revenues. And through our innovation activities, our customized solutions become specified into our customers' approved production platforms, which creates long-term recurring revenue streams that enhance the overall resiliency of our business. As -- now as a proof point of the success that we're having with innovation, you can see we've grown revenue from new product introductions by more than threefold, and we're specified into approximately 85% of the top 20 new biologic drugs that are in the market today. And you can see on the right-hand side some of the examples of recent NPIs that we've launched in our bioproduction platform across all relevant modalities. We've also invested in growth by adding new capacity. And we've talked a lot about our efforts to expand our capabilities, increase -- including our geographic profile and augment our manufacturing capabilities to support our new product introductions. In 2022, we ramped up capital investments to approximately $150 million, which you can see is nearly a threefold increase from where we've been historically through investments in digital enhancements like e-commerce, content enrichment and a global quality management platform. But now, we've also opened a new distribution center that I was able to visit in the fourth quarter in Dublin, Ireland. We added a new CGMP manufacturing center in Singapore. And we increased our capacity across our manufacturing network, including some of our flagship sites in New Jersey, Massachusetts and Ohio. And while we talk a lot about our capital-light model that requires we invest roughly about 1% to 2% of revenues, we're certainly eager and willing to make investments to continue to drive growth. The third lever to accelerate growth that I wanted to highlight is M&A. As you know, we've completed the integrations of our 2021 acquisitions, and we remain focused on delivering the commercial synergies that we had identified. Importantly, we've leveraged the learnings from these transactions to augment our model, including an expanded business development team and strategy team. We made ongoing improvements to our target identification and our diligence methodology and a focus on building a robust pipeline based on our unique access to and insights from our network of customers and suppliers. As we talked about at our Investor Day about a year ago, we've got more than $8 billion of M&A capacity through 2025, which we can deploy across our focus areas that are shown on the right-hand side of the slide on targets that meet our financial criteria, which as we've described before, we include accretion to growth, accretion to margin, accretion to EPS and yield a high single-digit ROIC by year 5. And while we'll continue to deploy capital on deleveraging here in the near term, M&A remains an important part of our long-term value-creation algorithm. So before we move to Q&A, and let me wrap up by just reiterating our focus on living our mission of setting science in motion to create a better world. Our more than 14,000 associates around the world have a passion for science and for working hand in hand with the world's leading researchers and scientists and for solving complex problems. Our business model is proven. The bio we bring is clear, and it's in our DNA to be focused on continuous improvements. We've demonstrated that we can execute in a dynamic environment, and our core business remains quite strong. And as I look into 2023 and beyond, we're well positioned for continued high levels of performance. And ultimately, I hope that you're as excited about Avantor as I am. Thank you for your attention today and for your interest in our business. And thank you, Rachel, for the opportunity to present. Tom and I will now be happy to take your questions.

Perfect. Thank you, Michael. So everyone in the room, if you do have any questions, again, feel free to raise your hand. We do have mic runners throughout the room. But Michael, maybe just to kick it off here. So you even mentioned yourself that 2022 has kind of been a noisy year for Avantor. So now that we're nearing the end of it, I guess, what are just the key message that you want people to take away from this year heading into 2023.

I think where I would start is just by highlighting and reinforcing the strength and performance of our core business. We've delivered another strong year of growth and margin expansion and free cash generation, which will persist for us well into the future. Certainly, we encountered a more dynamic and uncertain environment than we had anticipated. COVID revenues rolled off quicker than planned. Our -- the 3 transactions in 2021 underperformed our deal model, and some of the supply chain constraints that flowed from the unwind of the COVID pandemic certainly created some headwinds that we had anticipated in the year. But as you look through that noise, I think it is important, and I think that's how we look at the business, the strength of the core business is fully intact. And I point to biopharma. We've had another really outstanding year of growth led by double-digit growth of our bioproduction platform. And I think we're well positioned as we look ahead.

Great. So maybe if we can dive into some of those issues that you faced throughout the year. Just on the consumable stocking with liquid handling, customers were facing supply chain constraints. They were probably over purchasing. And now we're seeing them work down that level of inventory. So can you just give us the latest in terms of how many more quarters do you think it will take to really work through that destocking. And then as a follow-up, some investors are concerned that this could actually be share loss as opposed to some potential stocking. So what gives you confidence that this is truly just stocking related and not some underlying share shift?

Yes, great question. I think I'll begin by highlighting the stocking dynamics that we've seen certainly are a reflection of the unprecedented constraints that the value chain experienced throughout the supply chain. And what we, in retrospect, have observed is that for product categories where there were alternative sources available in the marketplace, our customers around the world moved to try to secure their supply chains. And so what you found that occurs in maybe some more of the commoditized portions of our portfolio and, in this case, some of the staple liquid handling consumables that you referenced. We are confident that it is something that will be temporary and transitionary in nature. As we've talked over the last couple of quarters, we anticipate this continually improving through the first half of 2023. And I think our perspective on not has changed. We obviously stay close to our customers and -- we'll continue to do that to understand how their supply chains are improving. But as we work with our suppliers, as we look at market data, we do various market checks on this, we are confident that it is limited to a supply chain constraint and not something broader like share shift. In fact, we had a tremendous year of customer retention, customer renewals. And hopefully, as you saw from the press release this morning, we've also had some exciting new contract wins this year. In fact, we didn't lose a single contract that we had in our business, and our renewal and win rate was at record levels. So we continue to be very well positioned with our customers and are confident that the compelling offering and value that we bring to our customers is well recognized. We can triangulate with our suppliers of these products. And I know that they're saying the same trends as we are throughout their other channels to the market. So -- with us probably for another 1 to 2 quarters, but it will gradually improve as we move through the year.

Great. Helpful. Maybe what about from a macro perspective? You flagged some of the softness in Europe, also in some of your industrial segments related to Ritter. So can you just give us an update on how those businesses and the demand trended in the last few weeks post 3Q and the latest update?

Yes. As I mentioned in my presentation, we're just in the midst of our close, and we'll give our fourth quarter results here in a few weeks. So would just rely on the comments that we've made probably early in the quarter in that as we entered the quarter as we worked through the quarter, there certainly are some headwinds that we had identified, and I don't think we have anything to add to those. We've seen certainly a slowdown in some of the industrial-related applications in Europe and certainly some of the stocking phenomenon that we talked about has played out as we had anticipated. But as I look at our setup for the quarter as we head into our earnings -- close the books here over the next couple of weeks and prepare for our earnings call. I think we're comfortable with the setup that we've provided.

Great. Maybe just a question on 2023. I understand you're not providing formal guidance, but can you just kind of walk us through how you're approaching your philosophy towards guidance next year. Obviously, this year didn't plan out as we expected. You both have noted before that you want this to be a beat-and-raise story. So how are you managing layering in some conservatism, especially with some of these question marks around macro industrial in Europe, without sandbagging numbers too much. So what's the latest on the philosophy towards guidance for '23?

That's a great question. And I don't know that we've necessarily -- would look to change our philosophy on how we try to guide on our performance. We try to be prudent in all and transparent in all the information that we provide in our business. If I reflect on 2022, and as I look at into 2023, I think probably the one aspect of this that does need to be accounted for is just the dynamic nature and uncertainty around some of the macro factors that we've talked about. And so probably important to give consideration of some of those factors as we prepare our guidance. But as I showed our long-term financial algorithm in the presentation that we have a high conviction around in 2023 and no different than in any year, that would always be the starting point for how we think about the year. And then we would layer in the various puts and takes for factors that weren't necessarily contemplated by that model. And in 2023, that would certainly account for things like our view that we'll roll off all of our [ COVID-related ] revenues, which is roughly $200 million or thereabouts. We anticipate ongoing currency headwinds that we'll factor in. We'll certainly try to take into account the inventory destocking in our liquid handling consumables that we've talked about. And of course, we also have to consider things like the inflation environment and where pricing is landing and those things. So I don't know if the philosophy hasn't necessarily changed, but I think we'll try to be prudent as we prepare the guidance to give due weight to the -- some of the uncertainty that's in the business today.

Great. Maybe just a follow-up on that. Since you flagged pricing, what's the latest that you guys are seeing on pricing? Historically, you've spoken about 1/3 price, 2/3 volume. Obviously, this year was an outpace on the pricing side of things. So how should we think about that heading into '23?

Yes, embedded in our mid-single-digit plus organic algorithm would be a split of price and volume contribution of roughly 1/3 price, 2/3 volume. And as we work through 2022 and the inflationary environment that we were operating in, it became evident that we were going to need to drive a much more aggressive pricing action that we had to do before, which kind of flipped the algorithm. We'll do the final math on it. But roughly, 2/3 of our growth in 2022 will have come from price, and roughly 1/3 of that will have come from volume. And I don't know -- as I look into '23, I don't know that the setup will be a lot different than that. Inflation is still going to be persistently high, causing us to probably take into the market or we have taken into the market pricing above our historical levels, and that process has been ongoing for a couple of months. And I'd say it's actually gone quite well. We'll fold that into our guidance. Will it be as high as what we delivered in 2022? I think that's probably a bit of a question for me, but it's certainly going to be well above our long-term algorithm.