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

All right. Great. Good afternoon, everyone. This is the [ Hale and Hearty ] group that's here for the 4:30 Fireside. So thank you all for joining us. My name is [ Eve ] Bernstein, and I am a new analyst at Bernstein. So I'll be initiating coverage on the U.S. life science tools and diagnostics space in about 2 months or so. I am really excited to be joined by Avantor and Michael Stubblefield, who is their President and CEO. So thank you for joining us.

Yes. Thanks for having us. Happy to be here today.

A little back on Michael. He's had the role at Avantor since 2014. Before that, he spent over a decade at Celanese, and he also spent some time with McKinsey as a senior expert in their Chemicals practice. We also have the rest of the Avantor team here and just wanted to say thank you to them for helping us prepare for this. They've been really awesome. And finally, again, to all of you, thank you for joining. A reminder that you can submit questions through the Pigeonhole app. So I'll be looking at them as we're going and want to make sure that we address the stuff that's on your mind also.

All right. So let's kick it off. So you're getting pretty close to a decade as a CEO at Avantor. And given that this is the Strategic Decisions Conference, you've led through a lot of big changes and had to think quite a lot about strategy in that time. So what strategic actions that you've taken, do you think have had the biggest impact on the business in that time?

That's a great place to start. I guess, anytime you're doing something for a decade, it's natural to be a bit reflective. And maybe where I would start is to just point out, it has been an incredible journey and transformation from where we started nearly a decade ago to what we have today, and we're super proud of having built leading life science tools business and maybe even more satisfied with the impact that we're having in living our mission every day and the impact that we're having in driving and enabling breakthrough science. And maybe a good place to start is to just describe a bit for the group here, what we've built and then happy to describe maybe some of the strategic actions that we've taken over the last 10 years that have led to the business that we have today. But as a player in the tools space, today, we have the privilege of running an integrated model that positions us to serve our customers from early-stage research and development, all the way through to the delivery of their finished therapeutics. And we're embedded really deeply in virtually every stage of our customers' most important activities from research to scale up to ultimately manufacturing. The business today is roughly $7.5 billion. We serve for specific end markets. We have an addressable market that's more than 80% or $80 billion in size, and more than 70% of our revenues are in the life sciences space. And I'll probably simplify the story for you and describe essentially the 2 things that we do for our customers. The first thing that we do is we offer a very comprehensive solution of products and services into the laboratory environment. And that leads us to serve scientists that are focused in research. They're focused in diagnostic applications, and they're doing quality control, quality testing activities associated with the testing and release of their finished new products. And so you can see then how that's applicable across the 4 end markets that we serve, whether that be in biopharma or academia or healthcare ultimately in the applied markets. We serve as a one-stop shop with a very comprehensive offering of more than 6 million SKUs to serve that scientific community. The other thing that we do then is we leverage that access that we have to that early phase research and development activity to see proprietary content that we customize and ultimately earn specifications on our customers' production platforms. And so that is the work that we do in our customers, therapeutic applications in biologics, that's the work that we do with our custom silicone formulations business in medical implant applications. That's the work that we do in semiconductor manufacturing, aerospace and defense applications. And so there's a very strategic rationale for why we have the access to the customer in early-stage research. And then while that's so complementary to what we do in the production environment. And that leads to a very sticky revenue profile. More than 85% of our revenue is going to be recurring. The model is built on consumables, materials-driven platform that has proven to be rather resilient across economic cycles. So that's the business that we're in and that we're running today. Now to your point about over the last 10 years or so, what are the strategic actions that we've taken to transform the business and to build the engine that we run today. If I think back to the early days of 2014, probably the first priority at that point was to really pivot the portfolio heavily towards bioproduction. The business was quite fragmented. We were focused on a lot of different end markets, many outside the life sciences area, probably less than half of our revenues were in Life Sciences at that point. But you could see the growth opportunities that were ahead of us in bioproduction. We have a premium brand in J.T.Baker that had a lot of traction and we'd earn specifications across more than 80% of the commercialized therapies at that time. And so we're very well positioned there, and we doubled down and rationalize some of the portfolio and starting to build the R&D engine more prominently and did a series of acquisitions to bring more content to the platform, more life science capabilities. And that was probably the period from like 2014 to, call it, 2016, early days of 2017. One of the things, though, that as we were doing that, that we started to recognize was where research was being done was fragmenting to a large degree, particularly for the biologics space. Historically, we had canvassed very credibly large pharma who have been responsible for developing the majority of the molecules that were commercialized at that time period. But with the emergence of biotechs, different funding sources, the emergence of the different capital sources that were coming into this space, certainly driving really promising science, you started to see significant fragmentation of where next-generation therapies were being developed. And so we were really focused strategically on ensuring that we had a way to access those development opportunities in early phase, in early stages because in a material-centric model like ours, our solutions get customized and you earn those specifications probably in kind of preclinical phases and certainly no later than like Phase I, Phase II clinicals. And so this early stage access for our model was really paramount. And so we looked at a lot of different ways to ensure that we could serve a highly fragmented market and ultimately decided to buy VWR for its access to the scientists in early phase research activities. And so now you're into the 2017 time period, where we were driving that acquisition to give us this access. And so then on the back end of that, you then kind of enter the phase that we're in now, which is really characterized by kind of an integrated workflow driven model where we're able to provide an end-to-end solution for our customers. We're ubiquitous across therapeutic areas. We have a one-stop shop solution for the scientists in the lab where we're able to leverage that access to seed the content to deliver these solutions. And it's been a really powerful model. And I think the proof point for us is, with this integrated capability, our growth rate in the lab has probably doubled. The number of customers we're serving in bioproduction has quadrupled in the kind of 2018 to current time period. And the percentage of commercialized molecules that I'm specked into has increased. And so the strategy has worked out fantastically well, and we continue to be very well positioned to capture what we think is a pretty terrific growth opportunity going forward, notwithstanding some of the -- the near-term headwinds and macro challenges that we do face. So you think about the differentiated value proposition and business model that we have developed and built over the last decade, that ultimately gets manifested in a financial algorithm, which for us is kind of mid-single-digit organic revenue growth, 50 to 100 basis points of margin expansion, kind of mid-teens EPS growth. And the business generates a tremendous amount of cash. It deleverages quickly, which, over the long term, gives us a lot of capital flexibility to continue to drive both top line growth as well as margin expansion through the M&A lever. So those are probably some of the more strategic actions we've taken during this time period to build the business that we run today. The last thing that I would point out that I think is really an important evolution of the model and maybe one of the bigger changes that I've seen, certainly over the last decade is our specific focus on embedding ESG and sustainability into our business model. We were -- we had probably a lot of ground to make up, and we really started to lean in on this over the last probably 3 or 4 years and we've made tremendous progress. We recently just published our updated sustainability report that's out there now. And hopefully, you get a chance to take a look at that. We just announced our commitment to set new climate targets in accordance with SBTi. We're a signatory to the UN Global Compact. So we're making tremendous progress in a lot of different dimensions. We're well ahead of the curve to exceed our 2025 emissions reduction targets, from a diversity standpoint, we remain on track to achieve parity from a leadership standpoint, from a gender diversity standpoint. And we've just got a tremendous amount of momentum inside the company from a culture standpoint, where the entire organization is really embracing the focus in that area. So that's probably another very positive development, I would say, over the last couple of years that very much is embedded in our strategy.

That's great. And I think it sets the stage really well to explain where Avantor has come from and where you're trying to go. Let's just set the stage a little bit on 2023, though. So you mentioned severe pockets, some headwinds. Can you -- you've reported recently, you've been to other conferences recently. You've talked about it. But -- can you just sort of orient us a little bit to how you think '23 is playing out and maybe implications for the back half of the year?

So if you go back to the early days of the pandemic, I mean, it's definitely been a pretty dynamic time to be running a business. And certainly, as we're on the back end of the pandemic, and we're dealing with the unwind of -- of a lot of the supply chain dislocations, it certainly has made for a challenging time, but the team continues to execute very, very well [indiscernible] what happens to be a pretty challenging time. it's probably worth -- just reminding you of what we said on our first quarter earnings call about the second quarter where we said or I said at that time that we anticipated the quarter would look a lot like Q1, which was to say some of the destocking headwinds in both the lab as well as in viral production would continue to persist at similar levels. We signaled that the semiconductor end market for us would weaken sequentially. And I think we're obviously on the back end now of May have not quite closed the books yet, but I think it is fair to say those headwinds that we signaled are definitely real and they're definitely playing out in line with kind of what we had anticipated coming into the quarter and what we've talked about. I'd also say we've talked a bit about a challenging macro environment. There's a lot of things working against the economies around the world, whether that be inflation or some of the geopolitical actions and concerns around recessions and such in certain regions and countries. In environments like this historically, if you look at our portfolio, these times typically get characterized with a bit more caution around our customers' capital spending outlays. And I would say, as we move here into the second quarter, we're definitely seeing that play out for us. About less than 15% of our portfolio is in that capital, an equipment and instrument category, but it's not unusual, and we talked a little bit about it over some of the forms that you mentioned that we've spoken at it and in an environment like this, that's a category that you do tend to watch pretty closely. And in previous downturns or periods are characterized by macro headwinds, you do see a bit more cautionary spending patterns from your customers in that area. And I think others have seen similar trends, and we're certainly seeing that in our own business. As I think then ahead to the full year and what we've said about the full year, that's probably worth reiterating a few of the assumptions that we've highlighted. One, we've indicated that the guidance that we have out there for the full year assumes kind of similar macro conditions, customer activity levels from what we saw in Q1 kind of persisting through the balance of the year. We've assumed that the destocking headwinds are persistent at levels that we're currently seeing kind of through the -- the balance of the year. We've given some pretty specific assumptions around the semiconductor end market, where we indicated sequential softening from Q1 to Q2, but then the back half of the year looking a bit more like Q1 and we're -- it's a pretty consolidated end market. And so we're pretty close to our customers there. And as I sit here tonight, I think that's still a very good assumption from -- based on the conversations we're having with our -- we're having with our customers. And so those are, I think, the key assumptions that we've embedded in the full year, and it obviously continues to be a pretty dynamic environment and we've got the team focused on executing that plan and controlling the things that we can certainly control particularly some of the cost and productivity actions that we're taking and really leaning in hard to drive the revenue opportunities that we've got in front of us. But that's how I would probably characterize the second quarter and the full year.

Good. Dig in a little bit on destocking. So I think for a lot of peer companies, the narrative out there is it's a bioprocessing problem. For you, you've identified it as bioprocessing but also core lab consumables. Is that unique to you? Or can you maybe sort of put a little bit of meat on the bones to paint the picture of what that looks like?

Yes. So you mentioned that we have kind of destocking headwinds in both our bioprocessing part of our business as well as in the -- some of the consumables in the lab. And I would say that the entire value chain is struggling with a highly dislocated supply chain through the COVID times. It's kind of unwinding and normalizing as we come out of that time period. So the dynamics that we're seeing are definitely not unique to us. Our suppliers are feeling it, our competitors see it. And I think maybe we were one of the early ones to start to signal some of these dynamics. We started to talk about some of these things as early as the third quarter of last year. But I think if you look at more recent commentary, I think you see the entire space struggling with some of these dynamics around just a reset and a normalization of the supply chains that became highly dislocated during COVID. And in the lab specifically, we talked about these consumables. The categories where we see this phenomenon, I would say, are in kind of staple categories within the lab. So really basic, but essential, primarily in the plasticware area, where you had products that were being used in -- across virtually every workflow in a lab, including PCR testing for COVID, which has really drove -- what drove the spike in demand and kind of created the panic and the run on the inventories, if you will. And so you have a lot of -- whether you were doing COVID testing or not, virtually everybody scrambled to protect their supply chains and ensure that they didn't shut their lab down because you were missing a pipette or a centrifuge too, that would be the last thing you'd want to do. And so for these products, I think they were able to probably identify some nontraditional sources of product to keep themselves going. And as the demand for PCR testing fell off as quickly as it did, and everyone was making investments to make more capacity available, you ended up with kind of a glut of inventory that the industry is trying to work through. And we started to see that as early as the third quarter. And we're staying close to our customers to see how fast that we can work through that. Our current assumptions obviously lead us to the conclusion that will be with us through the balance of the year. But there are positive signals around the improving health of that inventory situation. We have fewer customers reporting that they have excess inventory and those that are reporting access inventory are indicating certainly that their inventory levels are coming down. And we have nearly 2,000 associates that are on site with our customers every day and embedded there. And so as we've been able to get those people back on our customer sites post-COVID, we can actually start to see some of this inventory, and that's another data point that we look at to validate that, yes, the inventory is definitely coming out. And I guess, adjacent to that is, look, the plasticware is just one component of the workflow, and there are many other components of those workflows that are being consumed that were not overstocked. And so we also, I think, take -- we take also, I think, some comfort in seeing the demand patterns of those non overstocked categories, seeing some pretty healthy demand in those cases. And so the inventory will definitely come out. It is a temporary phenomenon and it's something that is not unique to us. Our suppliers and our competitors are all saying it.

On the bioprocessing side. Any patterns that you're identifying in terms of where the destocking is greatest? So customer segments, upstream downs? Any color there?

For us, it's primarily in the single-use consumables area. So it's things like peristaltic tubing. It's things like tubing for assemblies and manifolds that intended to be rather standard sizes that were used across a lot of different applications. So very similar to what I described in the lab. You had a dynamic where because of the vaccine demand, you had a run on inventories, people got nervous even for non-COVID applications and overstocked during that time period to protect their supply chain. So the dynamic is actually the exact same. And as demand has normalized, as vaccine demand has come down, as resin availability and tubing availability has improved, lead times starting to come in significantly. You see customers now, normalizing inventory levels and moving to more normal demand patterns. And -- and so the exact same dynamic we see playing out there is what I've described in the lab is underway. There's clearly good demand in terms of therapeutic production and output and you see the health of the inventory improving, but it's not improving as fast as we had initially anticipated, and we'll work through this headwind, it looks like through the -- likely through the balance of the year.

Let's talk a little bit more about that bioprocessing workflow. So in your opening remarks, you talked about moving more toward serving the entire workflow for a customer. And in a lot of ways, your really broad product portfolio supports that. And in some places, there are gaps. So in bioprocessing, for example, you clearly built up -- you've got a lot of the basic inputs. You've built up a fluid handling business, but there are other places like CRDMO, services or other parts of the bioprocessing equipment where you haven't built up that portfolio. Is that -- how is that going to work?

No, no, I think it's a great question. And certainly, I think it'll give me an opportunity here to kind of describe where we do play in the strengths of the business and the kind of the proof points of why we are so comfortable with the business model that we run. So when I think about my bioproduction business, it's about 25% of Avantor's revenues. And we're going to be ubiquitous across all modalities, clearly, the key driver of revenues today is monoclonal antibodies, but we're well embedded in the pipelines and a few cell and gene therapy commercializations that are on the market today, we're going to be well represented there. And clearly, we participated in the mRNA driven vaccines and -- and so we're going to be pretty well represented across the pipeline of any biologic therapeutic. And we play this space primarily through a material-centric strategy, meaning when I think about a basic biologic process, you have kind of upstream, cell generation and protein expression processes where we're going to be providing everything from process ingredients and carbohydrates, nutrients, vitamins, minerals, essentially anything that a living cell needs to sustain life, those critical additives that go into a cell culture media formulation is what we're going to provide. And the business model that we run here, I think this gives a really good opportunity for me to highlight how it works. So when I think about what the customer is trying to do in that part of the workflow, they're really trying to optimize that media formulation to maximize what the industry referred to as titer or said another way, the yield of the reactors. So how many grams of protein per liter of reactor do those cells express? And it's an optimization that occurs in development where you're tweaking the formulation of the media. And it's our materials, whether it be the carbohydrates or vitamins, minerals, nutrients, the serums that go into that formulation that functionalize it that ultimately drive the yield in that step of the process. And so I have 13 innovation centers around the world. We call them collaboration centers where our customers would work with us collaboratively to optimize the formulation of our additives to yield the titer that they're looking for in their process. And so it's quite an intimate model that we run there. When you then think about the next step of the process, we'd characterize that or describe that as a purification step, where you now have the target protein that's been expressed that now needs to be purified. And so we would have a full line of chromatography resins that drive the purification as well as all of the buffer solutions that drive the protein through the process. And we would also have all of the high purity chemicals that drive the viral clearance and viral inactivation processes that are in that step of the process. Again, you're touching the protein, you're an intimate part of the process and you're optimizing and working with the customer to modify the process conditions in this case, you're maximizing the recovery of the protein through those processes. And we would do things like optimize resin formulations, for example, to enable them to take out one of the chromatography columns, for example, which might save them or increase their yield by 10%, which when you think about the value of that protein, that's a significant value add for our customers. And then you move downstream to the formulation stuff with the process where you have a purified protein that you're needing to protect and to formulate into a formulation that can be injected into the patient, they do that with our excipients that we would customize to address things like protein stability to address the -- the injection experience that the patient might ultimately have and you're modifying viscosity for example. And so you're -- again, you're touching the molecule in a very, very intimate way. And in that case, our materials would be actually injected into the patient. And so as the leading materials supplier of these types of components into that process, we're a critical part of that value chain. And there's obviously a lot of different players in this space that have complementary solutions. Some might provide some of the equipment, for example, some of them might provide filtration or media. We happen to be, I think, a bit unique in the solution that we do offer. And this is a workflow where the customer is not looking for a one-stop shop. The technology is too sophisticated, and to differentiate it, they do like our model of kind of best of breed, if you will, and some of the choice that we offer them. When I think about the single-use part of the portfolio, which is about 40% of my bioproduction offering, I'm going to have the only end-to-end [indiscernible] fluid management solution in the space. So starting from the pumping technology that allows me to move proteins through the process as well as raw materials into the process. We have all this tubing and assemblies and the connectors and manifolds that connect all the unit operations. We also are going to be connected to filtration skids and can build these skids using filtration technology that the customer would specify with not being tied to any one particular vendor or brand. And so it's actually quite an agile and customer-centric model that we run. And as the leader in these types of materials that we provide, we certainly don't feel any pressure to, oh, you better add the equipment or you're going to get spec-ed out. There are a couple of parts of the solution we do think are complementary, like having buffers and solutions together with our chromatography resins, we can optimize the performance of those materials together, having the direct dispense packaging bags together with the process ingredients that are going to go in those bags. We can tailor the -- the technology, the resin technologies and the impurity profiles of those to optimize things like impurity profiles and leach rates and such to optimize our system. Those are maybe some smaller examples of where some complementary solutions are helpful. But broadly speaking, it's not an end market that is driving for a one-stop shop solution. Nobody has it. Everybody has kind of identified their areas of strength. And so if we -- and I think the proof point for the strength of our model then is in just how ubiquitous we are across the modalities and the number of molecules that I'm specified into and it continues to increase. As I mentioned, a few years back, we're probably on about 80% of the commercialized molecules. That number today is north of 85%. And if I look at the pipeline, Stage 1, Stage 2, Stage 3, we continue to work on more platforms and to put more content on every platform that we work on. And so the business model, I think, is really starting to pick up momentum. And one of the things that the VWR acquisition brought us was the single-use content. And we built on it with the Masterflex acquisition and the RIM Bio acquisition, and it's now 40% of the bioproduction solution. But we'll continue to add content and capabilities where we think we have a right to play and that fit our business model. But I think we like the positioning that we have in this space.

You talked as you were discussing a role that you play. I think you used the word customized 5, 10 times. So it's clearly a core part of the value that you add to customers. And interestingly, guys don't even report R&D spend and yet so much of the value that you're driving seems to be really in this collaborative relationship with the customer. So can you talk a little bit about the R&D function? Is that sort of unique role that you're playing? Is it a benefit? Because then you're close to the customer? Or is it actually a downside because you're not making the next new product ex-widget that you can sell to 5 million customers?