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

Welcome. Day 2 of the TD Cowen Healthcare Conference. Dan Brennan, really pleased to be joined with me here on the stage, Michael Stubblefield, President and CEO of Avantor. So Michael, certainly thank you for being here and welcome.

Yes. Thank you. We're happy to be here again.

Awesome. Maybe we'll do like a high-level intro here. Even public coming up on 4 years, excuse me, you've been -- company has been public coming up on 4 years under your leadership as CEO. Strategy has been pretty consistent from our vantage point, deliver steady results from your consumables-oriented distribution business, allocate more investments to higher margin, faster-growing proprietary products, and delivered mid-single-digit revenue growth and above average peer margin expansion and looks luckily for M&A to accelerate the shift in a higher margin, faster-growing areas. So in your opinion, when you look back, how has the company performed against the strategy goals over this period and also during the last year?

I think it's a good place to start. If you look back at what we set out to do when we put Avantor and VWR together and kind of started out on our journey here, we are really looking to build an integrated end-to-end life sciences leader that can provide solutions to our customers from early phase discovery all the way through our customers' journey, including the delivery of their commercialized platforms, primarily in the biopharmaceutical area, but also in the implantable medical device space and other high-tech applications. So that's what we set out to build. And as we kind of now have the benefit of looking back over the last several years to see how that has played out, I couldn't be more pleased with the business that we have today. It's more resilient than it's ever been and is better positioned with more capabilities than we've ever had before. And if I look at maybe just a couple of proof points on the value that we've created in building this -- building out the strategy, one of the primary drivers here really was to leverage the channel access to position our proprietary content in more places. And we've seen, over this time period, about a 4.5 fold increase in the number of bioproduction customers that we're serving at scale. I think at the time of the combination, it was around 2,000 customers. And as I look at 2022, we probably served over 9,000 [ VWR ] production customers. So I think that's a pretty compelling proof point of how our strategy has played out. Interesting enough, we've also been successful in doubling the rate of growth of our lab business. So in a very unique way here, our strategy has been able to deliver growth for both of the legacy businesses that we've that we've brought together. And I think as a from a financial standpoint, I think the proof point is also pretty compelling. The CAGR across this period for our core business has been over 6%, driven more than 130 basis points of margin expansion. I think EPS growth has averaged about 35% during this time period, and we doubled our free cash flow. So the strategy has played out well. The investments we've made in the business have certainly positioned us for, I think, a long runway here. And I think the financial performance has also supported the strategy.

Terrific. Maybe just a couple of questions before we dig into some of the numbers just about the distribution business and then the proprietary products business, again, maybe from a bit of a higher level. But if you agree to get your perspective on kind of the growth profile of that distribution business, what's kind of assumed as you look out from a market share perspective, stable, gaming, losing and some of the recent deals you signed Catalent Janssen, like what kind of impact of these bigger deals have?

So I think, by the way, I think about our business, I mean, it's clear what the heritage of our business has been. But as we've now integrated it, you can probably appreciate, we've lost a little bit of sight to some of the original constructs of the business. And we now kind of think about it probably in 2 parts. And the first part may be worth highlighting here is our comprehensive offering and solution to service scientists in the laboratory environment to help enable them to generate high-precision analytical results. And that means then that I'm ever present in Life Science research. I'm present in diagnostics, QA/QC, essentially anywhere where scientists are needing advanced solutions to help generate whatever analytical results that they're looking for is where we're going to find ourselves, which means we're in labs across the world. And we've really then built out a leading platform here that's rooted in probably 3 or 4 key elements. Firstly, having a very broad product offering of both products and services. And we talk a lot about the 6 million SKUs that we offer our customers. And that's really important in that laboratory environment given the fragmentation of the types of things that our customers are working on being able to be that one-stop shop for the scientists that we serve is critical. And we certainly have a leading and quite compelling portfolio to do that. Ease of transaction and ease of doing business with us is important. So we've invested heavily in our e-commerce and digital platforms to make it easy for our scientists to find what they need and to get checked out quickly. And we talk a lot about those capabilities, the customized personas that we are able to deliver to the scientists to make it easy for them to do business with us. And of course, we also view that as a leading metric for growth is just activity across that site. And I think that's a pretty compelling capability that we have. And then lastly, just having a supply chain that can get product to our customers same day, next day. And we continue to invest to build out those capabilities to support growth, to put inventory and product close to our customers so that as they call off the demand we're able to be there for them. And then we wrap all of that with some pretty compelling services that give us a more intimate relationship with our customers, give us a seat at the table to see firsthand the type of challenges and things that they're working on that better position us to solve their challenges. And all of that then comes together for us in a way that allows us to continue to grow share in this part of our business. You referenced a couple of customer contracts that we highlighted in the fourth quarter. And I think those are just great proof points of not only our relevance in this space but also the momentum we have in this space. 2022 was a great year for renewals and contract wins. We talk about our strategic partner accounts, which are our largest, most complex multinational accounts that we have, I think we were 100% renewals on the contracts that came due there. We had some pretty compelling new wins. We referenced Catalent in the fourth quarter. And I think we start the year with a lot of momentum from a customer standpoint. And for us, that is a great indicator of just what we're able to do for our customers, the value proposition that we offer to them, and it's a great show of confidence on airport to extend these relationships because these are contracts that tend to run for at least 3 years, if not fiber, in some cases, 7 to 10 years. So it provides additional stickiness to our business. You mentioned earlier this is a consumables-driven profile, our business with more than 85% of our revenue recurring. And one of the elements of this kind of sticky recurring revenue model is the long-standing relationships that we have with our customers.

Okay. Great. And then maybe just one more high level and then we'll get to the number. So your proprietary business, which is largely consumables-oriented as well, we'll get to bioproduction in a moment. But if you strip away bioproduction, what are the key elements of leadership areas in that business? And similarly, kind of what are the key growth drivers for our proprietary products?

So we have simplified, I think, the understanding of our business into kind of 2 pillars, if you will. And I just talked about our lab solutions platform with the content we supply into the lab. The other part of our business model, of course, is our proprietary customized production platform. And these -- this integrated business is really important. This integrated business model is important because my access to the scientists in the lab is where I customize solutions for my customers' commercial platforms, and I scale with them and serve those platforms at commercial scale. You referenced bioproduction, which we'll get to here in a second. But there are also many other platforms that make up that part of our business. We have a leading medical-grade formulated silicone platform, that is spec into virtually all implantable medical devices that would be in the body for more than 30 days. We have a pretty novel solution into the semiconductor space, aerospace and defense. So there are a number of these platforms where our customers are relying on us to bring customized, high-purity solutions that get spec-ed into their process. In the case of bioproduction, it's going to be part of the regulatory filing. In the case of a semiconductor, it would be part of the process of records. And it works the same in that once you're specked in, you'll service that platform through the life cycle of your customers' product, and it becomes a bit of an annuity in that regard. And so you have this access that we get through servicing the scientists in the lab. We customize the product through our innovation capabilities and then we service those at scale. And one of the unique advantages we have in this space is our ability to produce GMP products, not just at production scale, but also offer those same products using the same quality systems to our customers in the lab. And that's retail been one of the trends that we've seen play out over the last number of years is the scientists desire to use GMP materials earlier and earlier in the process and working with us, they can now use those materials right from the beginning of the discovery work. Qualify us once and not have to switch at any point as they scale through clinical trials or even into production, which is an important part of our value proposition.

Great. Okay. So maybe shifting over to like the outlook for '23. Your core organic ex-COVID would guide of 2.5% to 4.5%, you basically indicated that 4Q includes a 250 basis point drag from macro headwinds. So ex those you're kind of 6% which is 6% at the high end, right, of your 4% to 6% LRP. So maybe just walk us through how you size the different risks and to what extent you provided for some cushion in the guidance in case things worsen?

Yes. So your math is right. The guide here is 0% to 2% from an organic standpoint. The COVID headwinds in our numbers this year are certain. We're not contemplating any incremental COVID revenues in 2023. So we know what they were in 2022. So we know that there's roughly 2.5% headwind coming from the COVID roll-off moving from about $190 million of revenue last year to essentially 0 this year. So that takes you then from the organic midpoint of 1% up to the 3.5% that you've cited at -- for our guide. Now the -- we're contemplating about 250 basis points of macro headwinds in that number, which gets you to the 6% that you referenced. And that would cover things like the liquid handling consumables destocking, it would cover the destocking that we see in our single-use portfolio within our bioproduction platform, and it would cover some of the macro risks that we see in the industrial sector, particularly in the semiconductor area. And so that gets you kind of the high end of our guide. Probably also important then to adjust that at least in the context of comparison to our long-term guide by acknowledging that we also are benefiting from probably 100 to 200 basis points incremental pricing in 2023. That is higher than our -- what we would typically think about in our long-term algorithm. So in a normal 4% to 6% growth environment for us, it would be roughly 1/3 price, 2/3 volume. In this hyperinflationary environment that we're in, that formula has reversed. In 2022, it was kind of 2/3 price, 1/3 volume. And as we see the year playing out, inflation is -- continues to be stubbornly high, which has caused us to take pricing into the market at similar levels as what we had last year. Maybe it's not quite at the same level, but it's close enough probably for modeling purposes to assume that it will be, again, kind of a 2/3 price, 1/3 volume year. So the way I see the guide then is if you're starting from a base of 3.5%, you take these macro pressures of destocking and the semiconductor headwinds we've noted gets you to 6% probably take out a point of price. So I think probably I'd have you think about our guide out of the gate here is the midpoint of our long-term algorithm, which we've outperformed over the last number of years. We think it's a prudent place to start. There's certainly some moving pieces to the number here, and we're going to see some pretty pronounced headwinds here as we've guided in the first half of the year that we're expecting roll off in the second half of the year. And allow us to close the year with a pretty clean slate and presumably positioning us to get back to our long-term algorithm as we head into 2024.

Great. I want to get to margins in a moment. Just from a high level, yesterday from what we heard from some of the tools vendors. I mean, generally very consistent messaging on pharma, although one of the larger consumables players did mention that they are seeing some headwinds right now, whether it be from COVID comps, whether it be from maybe a little macro, maybe a little bit of even IRA looking ahead. But net-net, anything like as you look at your pharma business and the trends like, I don't know what you've incorporated outside of bioproduction more of the traditional R&D side, like how is -- how did you factor that into 203? And has anything changed on that front?

Yes. So we talked a little bit here about our guidance and perspective on the full year. But certainly, we also -- on our fourth quarter call, we talked a bit about the phasing of how we saw the year playing out. And we were pretty particularly specific about how we saw the first quarter playing out because I think the headwinds, whether it's the COVID roll-off or the destocking dynamics that we do see in the supply chain as things reset post COVID are going to be most pronounced in the first quarter. Between the liquid handling destocking and the consumables or the single-use destocking probably talking about 500 basis points of headwinds from our business in the first quarter. You layer on top of that, the incremental headwinds from a pretty pronounced slowdown in the semiconductor space. And you can see then kind of how you get to our outlook on revenue for the quarter of minus 8% to minus 6% on an organic basis, minus 1.5 to minus 3.5 on a core basis. So certainly, the headwinds are going to be most pronounced. And as we -- 2 months under our belt here in the first quarter, we got -- March is the longest month of the quarter, so a big month ahead of us still. But things are playing out as we would have anticipated. We're definitely seeing the inventory draws occurring both on the liquid handling side as well as in single use as we would have anticipated. I think the piece for me that gives me some confidence in the forward outlook why we're kind of going through the destocking is the strength of the underlying demand. And we do have parts of our solution that are not subject to the destocking that we're seeing where we're seeing really good traction. So in the laboratory, for example, we're off to a really terrific start here on like lab chemicals, for example, which is going to be used right alongside these consumables that are being destocked. And so I kind of see that chemicals demand as an indicator of just the underlying activity, which also then supports the view that, that consumables inventory must be coming down. We also see a very similar dynamic in the bioproduction space, where my excipients and process ingredients demand is off to a really, really strong start. This year and then buffered by the destocking that we see in the Single-Use Tubing, particularly Masterflex and in our legacy offering. So the destocking is playing out as anticipated. But there are some indicators that you could read through to at least get confident in the underlying end market demand is there and is strong which kind of supports the outlook as the inventory resets.

Great. So margins, the guide is for flat EBITDA margins at the midpoint with I think it's plus or minus 25 bps on which is against the full year all-in reported revenue guide of flat to plus 2. So I guess the question is, and I know it came up on the call, but just love a little more color. Is it challenging to support flat margins at kind of flat to plus 2 revenue growth. I know you cited, I think we price mix productivity at 4Q as to lever. So would love a little more color on those and in particular, about this pipeline of productivity measures, which you mentioned on 4Q.

Yes. So let me just take you back to the algorithm. In a normal year, we would expect to expand margins roughly 50 to 100 basis points. I referenced earlier, our track record has been significantly above that even in 2022 with a lot of the pressures that we're facing inflation and destocking and such, we still expanded margins 110 basis points. So traditionally, we've done markedly better than that. Out of the gates here, we're taking a view here that given the dynamics that we've talked about, that we see it somewhere around flattish, maybe 25 basis points of compression to 25 basis points of expansion, which is clearly below our long-term algorithm. But we think it's well informed by the various levers that we would normally have at our disposal to influence margin. We talked a lot about commercial excellence and how we manage kind of price relative to inflationary pressures on our cost of goods sold. And although I mentioned price is probably trending higher than we would have in a normal year, it needs to offset the inflation that we're seeing. So the way I probably think about price relative to COGS is we're getting the customary contribution to our margin expansion as we would in a normal year. We're just needing to raise price higher in order to do that. And that's -- we're pretty well through that process. At this point in our cycle, we've got those prices in the market. And as orders come in, they'll be priced at those levels. And I think we're in good shape from that lever. Mix is important. There's -- I think we talked a lot about the importance of the growth of our proprietary offering just given the disproportionate margins that those carry relative to our third-party offerings. And when you look at the COVID roll-off, some of the destocking, certainly the semiconductor headwinds that we're seeing, those are all in pretty margin-rich product categories for us that certainly create a headwind for us. I think if I just look at COVID, for example, and the semiconductor headwinds that we'll have to margin. It's probably more than 80 basis points on a full year basis. So you can see that it's pretty meaningful. And then you're mentioning a third level around leverage. It's a pretty significant fixed cost base to execute our model. And we get when the -- in times when volumes are growing, we get a lot of leverage on that. And a traditional year, that would give us a pretty nice tailwind from a margin expansion standpoint. As you see $190 million of COVID roll-off, you see the destocking -- inventory destocking, some headwinds in the industrial business, volume growth is going to be somewhat muted, which means you're going to have some headwinds there from absorption standpoint. And then kind of the last lever that we would then pull to manage margins is around productivity. And the way I typically think about productivity is we would leverage the Avantor Business System to drive productivity to offset fixed cost inflation. And we've got a really good track record of doing that. So in a hyperinflationary environment that we're in, we're not needing to kind of start a whole new set of activities. We have an ongoing pipeline of productivity that we're driving. Inflation is higher this year. So we're and it's -- we've been in that environment for a couple of years. So we've been doubling down on things like automation and footprint optimization and leveraging a pretty well-developed offshore capability that we have. We have over 2,000 associates that are sitting in low-cost regions in Pune and Coimbatore, India and Bucharest, Romania and in Mauritius that give us a nice footprint to be able to manage some of these costs. So we'll pull that lever hard again this year to try to offset the inflation. Notwithstanding there's going to be certainly some headwinds coming from that. So that's how we think about it. And I don't think we view any of these headwinds as any more than transitory. I think we've got an agile model that allow us to deal with them this year. And I think we see a clear line of sight to the long-term margin expansion algorithm clearly being intact.

Great. So maybe jumping into bioproduction here. I think your base ex-COVID grew over 20% in '22 and your guide assumes mid-teens, I believe, in '23, and that's also, I guess, within your LRP. So it's -- you look at Sartorius, Repligen, you look at Danaher, you try to pull Thermo's numbers out and certainly, your numbers are probably towards the upper end of that. I mean to Sartorius has certainly been up there, but there's been a lot of volatility in the market from this inventory drag roll off. So I guess asking you like what really drives that growth? Obviously, you're a leader in buffers and excipients, you have the single-use capability. But just give us a little flavor for is your [ SAM ] growing at that level? Are you growing ahead of it? Are you gaining share? Just kind of what -- what are the key components of your growth?

This is a really important part of the story to understand. As we sit here today, bioproduction is about 25% of our overall group revenues. And it's a space that we continue to outgrow the market, probably by 200 to 400 basis points and probably have done that now for at least the 9 years that I've been running the business. And I think it speaks to just how well positioned we are in this space with the technologies that we have. We're going to touch these molecules, probably more intimately than almost anybody out there with a comprehensive GMP offering that allows us to provide critical enabling content into the upstream processes around cell culture. So all of the additives and carbohydrates and minerals, vitamins, everything that the cell needs to have to sustain life and to promote protein expression. We're going to be providing all that content as you move downstream into purification, we have a complete line of chromatography resins. We're a leading supplier of buffers and high-purity chemicals that promote the viral clearance activities. And then we're going to have the leading franchise around excipients that are used in the formulation step. We're going to connect all that with a pretty comprehensive and in fact, the only end-to-end aseptic fluid management solution and industry, starting with the peristaltic pumping technology that we acquired from Masterflex and then through with the tubing and manifolds, components and assemblies, 2D, 3D bags that are used throughout this workflow. So we're very well positioned. The single-use trend has been a really nice growth driver for the business, growing well above 20% for a number of years now. The chemicals piece continues to grow mid-teens plus. And it's all driven by a pretty strong and growing monoclonal antibody environment. And then as we look ahead, our technologies are also relevant in the emerging modalities in cell and gene therapy, as well as an mRNA and other platforms. And so we're going to -- we're running a model here where we're trying to be lined up behind all these modalities across all of the candidates in virtually every stage of the development. And I referenced earlier the number of customers that we're supplying in this space of more than 9,000. And if you look at the number of customers that are in Phase I through Phase III clinical trials, you're going to come up with a number that looks an awful lot like that, which is to say we're going to be standing behind nearly every candidate that's out there which gives us more shots on goal, obviously, and puts us in a position on having to pick winners and losers. Our content is relevant to virtually every development that's out there. We then have the purification capabilities to provide relevant content. We have more than 13 innovation centers that allow us to do the customization work that our customers need us to do. And then I have a leading footprint with GMP capabilities in all 3 regions of the world, which gives us access and coverage around the world. And so you kind of put all that together, and we're running a model here that for nearly a decade now, has outgrown the broader market by probably 200 to 400 basis points. And I think we're set up for another year like that. We're certainly focused on another year of double-digit growth in the space. About half of our COVID roll-off this year will come from vaccines, which will temper the number a bit. But on a core basis, we would still envision another year of double-digit growth in bioproduction.

And like the 22% you had last year, was there something? Was it a comp? Or was there something that elevated that number some traction and mid-teens certainly would be great, but like how come the step down from 22% to 15%, again, I'm not taking away for [indiscernible].

Our LRP contemplates mid-teens plus growth is what we would anticipate in this space which I think ties well to the expectation that if the broader space is growing low to mid-teens, we're going to be growing a bit faster than that, just given the makeup of our portfolio. So we've been running a bit above 20% in the last few years. I don't think the necessary have line of sight that we continue to grow at those levels. But if the underlying demand is stronger than what our algorithm would imply, we would certainly be there among some of the highest growers in our space.

Great. So the Advanced Tech and Applied Materials segment, I believe, grew high single last year, typically with mid-single. I think that's what you focus on for '23. But you've already mentioned here about the semiconductor impact that you've kind of baked in. Can you just kind of unpack that segment a little bit that mid-single, what kind of gets you there? Like what are the puts and takes there? And have you baked in enough cushion such that if things go south here that you could still hit that number?

Yes. So you're talking about a grouping of revenues. It's probably about 25% of our group totals, and it's split across probably more than a dozen different applications and end markets with no single end market application area comprising more than about 1% to 2% of our revenues. So semiconductors is a good example, oil and gas, petchem mining, food and beverage, aerospace, defense. These are kind of a sampling of some of the things that we would do. And it's the same business model, right? Your if you're in the lab of one of these customers, you're supplying all the same consumables and chemicals, reagents, equipment instruments to facilitate. In this case, probably a QA/QC analytical result, or we're spec-ed in with customized content into their production platforms in the case of aerospace and defense or in semiconductors, for example. So the business model works the same and is in our Life Sciences business. Leveraging the same infrastructure, typically a mid-single-digit grower and an important contribution of margin to our business. It grew well above that last year. It was high singles, low double-digits virtually every quarter. Really led by strength in the semiconductor space. And I think it's been well published, what's going on with the semiconductor reset at an industry level that will have that space off in a pretty meaningful way this year. I think more than double digits kind of numbers. So net-net, what we're taking into our 0% to 2% full year guide here is the expectation that the applied markets for us are down low single-digits. So compared to a high single-digit baseline for 2022 we think probably more in terms of low single-digits, which you kind of put it on a double-stack basis, it gets you back to that mid-single-digit growth that we would expect in our long-term algorithm.

So we have about 50 seconds. I have to have a couple of up but maybe we'll just hit the M&A proof point. I haven't met Kitty yet, but certainly, Ritter, Masterflex, went through some bumps here, some beyond your control, but hopefully in a better spot now. Just what's the outlook this year? Are you guys -- should we be surprised to see you deploy capital this year if you found the right deal? Or do you want to get a little more traction for Ritter, Masterflex and show their on the pace you expected so it will be more of a '24 event?

Yes. So we've been busy building the -- extending the capabilities focused on driving the commercial synergies of the deals that we closed in '21. The market really isn't open for M&A. You see the odd deal here and there. So I think our near-term priority continues to be deleveraging. We ended the year at 3.7x. We generate a lot of cash this year and look to preserve flexibility for when the market is more conducive to deals.

Terrific. Well, we're out of time. Michael, thank you very much for being here and thanks, all, everyone for being in the room.

Thank you. Thank you all.