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

Thank you for joining us. Thanks for being here. My name is Mike Ryskin. I'm on the BofA Life Science Tools & Diagnostics team with the other senior analyst, Derik De Bruin. And it's my great pleasure to welcome you all here at wonderful, beautiful Las Vegas for the 2023 version of the BofA Global Healthcare Conference. Really appreciate your attendance in this event. For our first session to kick off the conference, we are joined by Michael Stubblefield, CEO of Avantor. Michael, thanks so much for taking the time and coming out to talk with us.

We're happy to be here. Thanks for including us.

So just to kick it off, I mean, you reported 1Q results recently. Maybe you can give us a quick snapshot of what you saw during the quarter and sort of the factors that drove you to update your fiscal year guide?

I think that's a great place to start. When you look at the results for the first quarter, it printed pretty much in line with our expectations for the quarter, perhaps with a bias to the upside, the headwinds that we had cited coming into the quarter around destocking and some of the semiconductor headwinds played out in line with what we were expecting to happen in the quarter. Margins came in at the high end of what we had planned. We've got good traction on price. Our actions around productivity and investments in process improvements and enhancements, certainly coming through in the P&L in the quarter. And then I would say, as you go all the way through to the balance sheet and cash flow, really, really strong performance on cash flow. Cash flow was up 50% year-over-year and came in on a conversion basis at right around 100%. So really happy to see the investments and focus that we're putting into driving disciplined working capital performance, showing up in the quarter. So I'd say the quarter played out in line with what we'd expect. We're pretty pleased with the quarter. But as you suggest, as we look ahead, we did adjust our outlook for the full year really to take into account just some of the dynamics we're seeing here in the early days of the second quarter, primarily around the headwinds that we encountered in the first quarter. Our assumption coming into the year was that the destocking headwinds would kind of be behind us by the summer. The run rate that we achieved in those categories in Q1 was in line with what we had modeled. The exit run rate from Q1 was in line with those models. But it did imply a step-up in the month of April and actually sequentially through the quarter that we just hadn't seen at the time that we announced our earnings. And so what we've tried to do here is just to reflect the risk that there's a more gradual return to normal in those categories. And we've essentially extended those headwinds through the back half of the year. Semiconductor is a little bit worse force in the second quarter, just in direct connection to the production plans of our customers that -- those supply chains are going through the exact same normalization that we see in the life sciences space where you had kind of this dislocation of demand and really disconnected supply chains throughout the pandemic that are undergoing a pretty significant normalization and inventory reset. Our customers' production is probably off in the second quarter in the neighborhood of 70% or so. So a pretty small part of our business, but when you're off that far, pretty meaningful impact, and we'll -- we reflected that in our updated outlook as well. Now if you look through some of the noise of some of these temporary headwinds, we're actually encouraged by what we see in the underlying end market fundamentals. Activity level is definitely up across the board across all 4 of our end markets. You've seen -- we grew our academic segment in the first quarter, which is the first time we've done that in a number of quarters, and that felt pretty good. And when you look at just the activity levels in those labs, we're encouraged. But there are other bright spots as well. When you look at even in bioprocessing or in the lab consumables area where we have some of these destocking headwinds, the other content that we put on those same workflows that are not experiencing some of this inventory reset, we can kind of get a read-through into what the underlying performance of those end markets is. And so when I look at things like lab chemicals in a laboratory, which is going to be used alongside these liquid handling consumables that we're normalizing the inventory levels on, really, really strong quarter, for example. On the other end, if I look at our bioprocessing business, things like process ingredients, excipients, really, really strong performance in the quarter, which again is just, I think, indicative of underlying end market activity and demand. So pretty dynamic environment. Clearly, I think the team has done a nice job executing through some of the noise. And I think we're encouraged by the set-up as we move through the year.

Great. So just a follow-up on that then. Some of those bioprocessing destocking components you talked about, I think that was about 200 of the 300 bps in terms of the fiscal year guide change. What's your assumption for bioprocess destocking through the rest of the year compared to what you saw in 1Q?

I'd say a couple of things. So we're pretty close to our customers on this. And although we don't have perfect visibility, and we're not able to kind of call the timing as to when we see this kind of winding down in which particular quarter, for example. But what we do see is the health of the inventory situation is definitely improving. As we engage with our customers formally through various surveys, through the visits we make to the sites, the interactions we're having, we do see that there's fewer customers that have excess inventory, and we do with the amount of excess inventory that they're reporting is certainly coming down. So we're encouraged by the trend and the improvement in the condition of our customers' inventory, but it does seem that there's a risk that this persists with us through the -- well into the second half of the year. And so what we've tried to model here in our updated outlook is that things through the rest of the year look a lot like they did in the first quarter. So we're not really expecting a -- we haven't baked in a significant or meaningful improvement in the destocking dynamics in the full year outlook, and that had the effect, as you suggest, of reducing our full year guide by about 200 basis points to reflect that. And that's both -- that commentary that I just made for bioprocessing. I would make the same commentary and explanation for you in the lab side of the business as well. A lot of signals around the improving health, we have less visibility into that business on an order book basis. It feels like things are heading in the right direction, but we've also extended the risk that doesn't normalize until year-end in this updated outlook, and that's part of the 200 basis points.

Got it. And some of those surveys that you run at your customers, I mean, they give you pretty good visibility into inventory levels. Can you give us any more color on what you've noticed in the last couple of months, maybe compare where things were in the fall versus where they are now...

Yes. So really, since we first started to see some of these headwinds come into the business back in the third quarter of last year, we've got -- one of the things I really like about this business is just the access that we have to our customers. And so we leverage that access. We're getting our reps in front of our customers kind of back to what it used to be pre-pandemic. And so that's certainly helpful to be on the ground in our customers' facilities and to be able to see what's going on and have those conversations. But we also put in place pretty formal surveying and pulling that we do on a rolling basis. And if I compare the results of some of those formal surveys from, say, October to now, you've definitely seen the number of customers that are reporting excess inventory come down dramatically. And I would say both on the lab side as well as in bioprocessing it's probably less than half of our customers now reporting that they have excess inventory and that's a pretty big change from the inputs we were getting last fall. And within those customers who are reporting excess inventory, we've also seen that calm down. Initially, it was a lot of them reporting 6 to 12 months of excess inventory, and I would say that those that are now reporting excess inventory, it's certainly less than 6 months and a lot of those in that kind of 3- to 6-month range. So that's kind of what informs my view on and my comment that we see improving inventory health across the value chain, just not improving fast enough.

And beyond sort of the inventory and the destocking dynamic, both in bioprocess and lab and [indiscernible], you did touch a little bit on macro, just sort of on the margin there for the fiscal year change. Could you expand on that a little bit where exactly, what customer or geography?

Yes. So I mean, I think we're all aware of what's going on in the macro environment. You've got inflationary environment, rising interest rate environment, certainly, the geopolitical activities that are around the world. It is a dynamic and challenging macro backdrop to be running a business in. But when you look at the performance of our business, one of the things I really like about it is just what a resilient platform that we do have. And yes, we're kind of fighting through some of these destocking headwinds, but I really like the set-up of a consumables-driven, highly recurring revenue portfolio. More than 85% of our revenues are recurring consumables-driven products that over time and over the number of kind of recessionary environments that the business has driven through, shown the business to be quite resilient. As long as our customers are in their labs and they're conducting research and as long as they're producing drugs, our portfolio is in good demand. And so that's kind of the backdrop that we enter into this with about 15% of our revenues are in the equipment and instrument category, and that's probably the most sensitive to the macro environment like we're in. And I think what we've tried to do here is just to reflect that there's probably heightened risk that the current macro environment persists through the balance of the year and could put some pressure on our customer spending. And so we've tried to reflect that in the updates that we've put out. And that's probably one category that I would -- that we certainly are watching closely is just how our customers are managing their capital spends in this environment. And for us, fortunately, it's less than 15% of my business. But in times of recession or customers watching the spend a little more closely, that's probably the category in our portfolio where you would see that -- those signs of stress show up. So that's how I think about that.

Great. And then the other area or the other customer where we've seen some red flags throughout the quarter from a lot of your peers has been pharma and biotech. In some cases, it's been biotech [indiscernible] biotech. In some cases, it's been a larger pharma. Just some early signs of cracks showing up after several years of really robust results. So could you talk about what you're seeing there from both customer classes.

So the biotech segment for us is an important segment for us, although it represents a relatively modest proportion of our overall revenues. There is a lot of development activities that, that group is driving and there'll be a lot of candidates that work their way through the pipelines that come out of that space. So it is a segment that we focus a lot on. At the group level, it's probably 2% to 3% of my overall revenues. It's all centered though in biopharma R&D, so if I kind of do the math for you on that, within my biopharma segment, which is about 55% of our overall revenues, we talk about within there, about 60% of that is in the R&D space. And if I double-click on there, that's what you would find our exposure to biotech. It ends up being about 10% of our biopharma R&D segment. Now to your point, the funding in that environment over the last couple of years has been at historically high levels, and we definitely do see a pullback in funding. But I think it is important to keep it in context. It's not dried up. It's not evaporated. There's still a lot of good science being driven there. And the funding, as we see it, is probably kind of back to pre-pandemic levels, which is still pretty healthy. And when we engage with our biotech customers, we definitely see them kind of managing burn rates and such and maybe prioritizing molecules to account for the current funding environment, but it isn't a really bad environment. It's just off of its historical highs from the last couple of years. That group as a whole was driving high single, low double-digit growth probably through the middle of last year. They grew for us in the third quarter last year, but we started to see things start to slow down modestly there in the third quarter, turned negative for us in the fourth quarter and sequentially moving into the first quarter was probably down even a little bit more for us. They were probably off mid-teens, something like that in the quarter. And it feels like that's kind of where it seems to be stabilizing for now. And of course, they're going against tough comps, just given the overheated funding environment that they're coming off of. But I think it will continue to be an important segment for us. I think at the end of the day, good science will attract funding, and I think we take a lot of comfort in just the programs they're working on, the health of the pipelines, the increase in approval rates that you see across all modalities and certainly, we've been encouraged by some of the recent approvals that we see in the marketplace. So yes, it's a headwind that we're kind of working through at the moment. It's somewhat modest for us in the overall [indiscernible] things. But we'll continue to pay a lot of attention to that segment. There's a lot of important molecules being developed by that group.

And then the other piece of the pie, Big Pharma, major pharma, how is that performing...

Yes. Big Pharma continues to perform well for us. They're subject to the same headwinds as the other segments we have. Certainly, the liquid handling consumables are overstocked in the biopharma labs of small and large customers. Yes, I think kind of staple consumable products, [indiscernible] and these kinds of things that you would use in virtually every lab. So it's not just confined to biopharma, but certainly, they do see some of those headwinds. And of course, we're dealing with the roll-off of the COVID-related revenues, particularly the vaccine that are impacting biopharma. And then on the processing side, that's where the things like single-use tubing, for example, and peristaltic tubing is overstocked for the moment. But beyond that, their balance sheets are really full. We're flushed with cash. Again, a lot of great programs moving through their pipeline. So I think we, again, kind of tie back to the long-term fundamentals of the space and the health overall of the space. And yes, there's certainly a lot of interest and excitement that we have as to our customers for things like cell and gene therapy, but we continue to be encouraged by the health and strength of the monoclonals' pipeline and there continues to be some pretty high-profile approvals coming out of those pipelines that give us a lot of excitement. So not only just in the core monoclonals business, but certainly, the future is going to rely also on some of these newer modalities, which are also really starting to get traction and take shape. And with our positioning the portfolio we have, we're going to be relevant across all of these modalities, and we're certainly going to be relevant across all of the [indiscernible] that are moving their way through those pipelines.