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

Good morning. Dan Brennan from the Tools and Diagnostics team here at TD Cowen 44th Annual Healthcare Conference. Really pleased to be joined here with Michael Stubblefield, President and CEO of Avantor. So Michael, first up, welcome.

Thank you. Glad to be here. Appreciate you hosting us.

Excellent. So listen, it's been 5 years, I think, since you guys came public, a lot happened, COVID, several notable acquisitions. And then you had this pretty boom-bust market for tools driven by pharma, China and whatnot. And now most recently, a CFO change in the reporting structure. So maybe how would you characterize Avantor's evolution, if you will, since the IPO through these events and secondarily under this new reporting structure and with Brent as a new CFO, kind of what do those things mean?

Yes, it's a great place to start, particularly this year actually marks the 10th year that I've been running the business. So as I look back, all those things you said are true. But there's actually quite a few things that have been constant throughout the last decade. I'd probably start by just pointing out that the inspiring pace of scientific advancement has been one of those constants, particularly the work which we seen around genomics and sequencing aided by cell biology and proteomics has really changed the therapeutic landscape in a pretty meaningful way. The other thing I would say is despite maybe the headwinds over the last couple of years, life science tools has been and continues to be, I think, a really terrific way to play these scientific trends. And then I would underscore our value proposition in Avantor rooted in kind of this discovery to delivery model has never been more relevant than it is today. Now you did reference a number of changes. And I think when I look back, there has been some pretty exciting milestones and probably highlighted by our VWR acquisition back in 2017, taking the company public in 2019 and a very deliberate pivot of our focus into biopharma and health care, a lot of expansion geographically, a lot of investments in our footprint, a lot of investments in our R&D and innovation capabilities, certainly a significant investment in our digital capabilities that has a position like we are today. And we're not done. You mentioned our transformation. We're really excited to be launching the next phase of our evolution, which I think is a natural evolution of where we have come from with the formation of these 2 new operating segments aligned with our customers' needs in the lab and in production in a very unique way, also unlocking significant operating efficiencies. So it's been a great 10 years. I'm really proud of what we've built and maybe even more excited about what's next.

Great. So maybe pivoting to '24 you're not alone and guiding for flattish roughly plus or minus growth in '24 for most tools companies. And while headwinds remain, do you think we're going to look back at these guides as we sit here maybe 1 year, 1.5 years from now and think, wow, management teams really set a low bar for '24 given the strength of some of the underlying drivers and kind of easy comps?

Well, I hope it plays out that way. In fact, of course, it's going to depend on both the timing and the shape of a recovery, which given our business model, we don't have the visibility that allows us to call when that's going to occur. And I'm sure we'll talk a bit about our guidance and our philosophy the way we've approached the year. And so we haven't baked in any anticipated recovery, although I would say we continue to be very encouraged by the leading indicators, the activity of our customers in the lab, our engagement with our customers. And certainly, if a recovery does materialize meaningfully within 2024, it would be upside to our current guide.

So in terms of the reporting structure, Bioscience production and lab solutions, you were fairly constructive not just on better aligned internally and how you guys go to market, but also what it could mean maybe for financial results. So how do we think about the benefits of this new reporting structure? And particularly, do you think it will translate in the impact on growth and margins?

So I think this is a much better way to run the business. No doubt, I think accountability is streamlined. The alignment with our customers' needs is certainly more direct. And I think also for those of you here in the room, it's easier, I think, for you to help probably understand our business. But aligning our business this way does focuses uniquely on what our customers are doing and allows us to better align our innovation portfolios, our offerings, and it should lead to enhanced growth and margin expansion over time. In the lab, we've talked about a model that's low to mid-single-digit growth, where we think there's some meaningful opportunities to accelerate both growth and margin by focusing on some of the high-growth workflows, enhancing our proprietary content continuing to invest in our leading e-commerce channel. And then in the bioscience space, which is characterized by our positioning within the bioprocessing space, which is about 2/3 of what we do on that platform, and we're going to continue to build out our offering to support our customers' innovations across all of the biologic modalities and continue to lean in and supporting the medical implant space. We think there's really attractive growth opportunities here, think high single digits, really attractive margins. And we think that, that provides a compelling value lift to our business long term.

So maybe kind of sticking with the outlook. Your guidance for '24 on the margin side, I believe it's 17.7%. That's down roughly 100 basis points, I believe, from where you guys on a full year basis where in 2023 you included increased costs year-over-year, and then you had this cost saving program. Maybe just give some color on kind of the key drivers of that margin guide between the base business and these costs and then kind of how much benefit you can get from this cost initiative.

I think it's pretty straightforward. We've talked a lot about the reset of a lot of our incentive compensation system, sales comp plans, our annual incentive plans, merit inflation, other fixed costs that you start to accrue at 100% beginning with the new year. And so we're in a situation where a lot of the cost resets happen January 1. And then as you suggest, we do have a pretty compelling cost-out opportunity that's linked to this multiyear transformation that we're driving. And we anticipate realizing within 2024 about $75 million of savings, and that will phase in as we move through the year. That results then in a situation where you kind of have the low point here in Q1 and margins should move up from here. But the key driver here is just the fixed cost inflation that we'll see largely linked toward the reset of our incentive comp.

And you mentioned 1Q number, and we'll go bigger picture here. But just kind of sticking with that, the 15.7% adjusted EBITDA guide, it is a material step down. How much of this incentive comp impacts the number? And yes, maybe just quantify it.

As I said, Q1 will be the low point on margins for the year, and it's really just due to the timing of all of the cost resets occurring January 1. And then we'll feather in the benefits of our transformation initiatives as we move through the year. So there's a little bit of a mismatch there in timing, but that's the key driver. And when we look at it within the P&L, gross margin sequentially Q4 to Q1 should be pretty flat. And then they'll tick upwards from there as the cost savings come in. The real step down is mostly on the SG&A line, where you see the reset of the incentive compensation systems.

Maybe just zooming out. You have this 20% plus adjusted EBITDA margin by 26% that you guys discussed. How do we think about the expansion that's enabled from the cost savings program alone versus the need for volumes to recover?

So what you're referring to there is at Investor Day, we talked a little bit about this kind of interim period from where we're at today to maybe exiting 2025, getting into '26, where we felt that our business would somewhat normalize during that period. And one of the metrics that we put out there was we felt that 2026 would be north of 20% from an EBITDA margin perspective. And we actually had quite a lot of conventionally set it and we still believe that. And now that we've given you some more granularity on the $300 million cost transformation, you can see just with the impact of that and how that phases in, that we can largely get there just on our -- the things that we can control. We don't really need a strong market recovery to happen in order to get there. And when you look at just what we've guided to this year and the -- with Q1 being the low point and how we see things phasing in, it's not unreasonable to see us exiting this year in and around 19%, if not a little bit better, which leaves you a much shorter pot to get to 20% by the end of 2025 and really can get there primarily with our cost actions. And similar to any recovery on the top line, the incrementals here from a margin standpoint are going to be, I think, pretty healthy, when we can get the additional benefits of mix and volume leverage that would then come in on top of this. So I think we've got a lot of different ways to get there, and we continue to have high conviction that that's the right way to think about the business.

And in terms of the overall guide for this year, I think it's minus 2% to plus 1%. Like what would be the key swing factors? I mean maybe you'll talk about the bio production business. But just as we think about what could take you above or below, what are the 1 or 2 areas that we should focus in on that you think have that potential?

It's probably helpful just to remind you how we have guided the year, the philosophy that we've baked in here. And similar to how we managed the outlook and guidance for the second half of 2023, we've taken a similar approach this year, which is to say we're looking to build in kind of existing run rates, the impact of pricing that we have line of sight to and then just any differentials in business days or timing of specific orders. So really trying to take a prudent approach here based on what we have line of sight and visibility to today. And when you kind of put all that together, it results in the range that you talked about centered around minus 0.5. I think the range there really is just meant to account for the normal variation in a business of this scale. And just to reiterate the point, we're not factoring in or anticipating or meeting any kind of market recovery in order to deliver these numbers. And the way it phases out is I think there's a little more than 49% of the revenue in the first half and a little less than 51% of the revenue in the second half, just to illustrate that point that it's really kind of run rating based on what we have line of sight to today, plus how the pricing phases in as we move through the year.

And last 1 there. I mean you did bake in a pretty steep like down in Q1. If we look at stack trends, if those are accurate or not, it looks like it does imply like a deceleration. Is that just providing a cushion? I think you're guiding down 5.5% to 6.5%. Just kind of thoughts on that? And presumably, if we're sitting here in March, kind of first week of March, is there any thoughts on how that's going?

Yes. I mean just to reiterate, we've taken the run rates from Q4, translated those into Q1 with the contribution that we anticipate getting from price. And I also remind you, we had the benefit of kind of setting the Q1 guidance in the middle of February. So we obviously had the benefit of saying what January was and a good part of February. So we think what we've put out there is certainly prudent based on the exit rates we saw in 2023 and what we're seeing at that point in the quarter. So consistent with how we're trying to manage the messaging on a full year basis, I think it's prudent way to get out of the gates here.

Okay. Maybe switching over to bio, within Bioscience production. I think the guide for the year reflects down mid-single digits, and 2/3 of the business is bioprocessing, which I believe that business was maybe down around 10 exiting '23 in the back half of the year, and I think it was like that for the whole of the year, too. So maybe just kind of dig into that business. You've been pretty optimistic about some of the lead indicators, what you're seeing order trends. Just give us some color on how you thought about that business and kind of the math behind the guide?

So within the Bioscience Production segment, about 2/3 of the exposure there is in bioprocessing. And for 2023, we think we delivered best-in-class performance on that platform. The business was off mid-single digits on a full year basis. It was down high single digits in Q3 and Q4. But overall, for the year, it was down mid-singles, which even if you were to normalize for our modest exposure to China, I think you'll find that that's probably best in class for bioprocessing. And what we've done consistent with how we're guiding at the enterprise level, we've taken a similar approach for bioprocessing, taking kind of Q4 exit rates, translating that into Q1, modest impact from pricing. It's running up against a pretty difficult comp. And so with Q1 last year being the high point, and so that just results in Q1 being off mid-teens or thereabouts. But on a pretty similar revenue basis, actually. And as we move through the year, the comparables weaken a bit. We anticipate the bioprocessing being off for us. Around mid-single digits is the way we've guided it.

And kind of any comment on order trends? I think you've talked about order trends improving.

So order trends in Q4, as we talked about on our call, had improved sequentially from Q3 modestly. We see that continuing through the first part of the quarter here in Q1, but not at a level that we would characterize as a step change. And it certainly didn't, not at a level that caused us to change our guidance philosophy. Activity levels remain strong. And if I look at the headwinds we were seeing last year, I do think we're in kind of the last innings, hopefully, of destocking of the raw materials. And I think our customers are making pretty meaningful headway in also building down their excess inventories of bulk drug substance inventories. But the activity levels continue to be quite strong there. We're pleased with the engagement that we're seeing, good drawing activity, good quoting activity, and we'll see when this turns around. But the fundamentals and the setup, I think, long term, continues to be very, very robust.

And bookings turn, is it going to be kind of a snapback do you think? I mean like how do you think growth will materialize? I mean could you move above at some point during the initial phases above your low double-digit type growth rate? Or just what's the -- what's kind of the math as this inventory finally gets depleted?

I mean that gets into trying to predict the shape of what the recovery is going to look like, which I probably won't be speculating on what I think that, that might -- what that might do. I think what we look at, of course, is our lead times and how we think that, that will normalize. We're sitting around 2 to 3 months of lead time now, and customers will respect that as they place orders. And so we'll see whenever it does happen, we'll see it with that kind of a lead time just based on the visibility that we have into our business. But we're coming off a year of record FDA approvals. There's a lot of excitement of -- this year is going to be another strong year of approvals. Patient demand continues to be high. A lot of these new therapies, a lot of these new modalities are really starting to get traction. So we couldn't be more bullish on the fundamentals and have a strong conviction that long term the space will grow double digits, and I think we're well positioned to continue our at least decade-long run of outgrowing the broader market here by 300 to 400 basis points.

And in terms of like your, we did like an R&D tour a couple of years ago with you, and there's been a push to continue to evolve the portfolio and continue to move into kind of more proprietary areas in bioprocess. Like kind of where does that stand? Like just what would you call out as the core competencies? Obviously, excipients and buffers are something that you've done very well a leadership role in. But like has the portfolio changed a lot? And is there just, I don't know, maybe higher value added, better pricing? Just kind of give us some flavor on your portfolio.

Yes. So if you think about our proprietary offering, particularly in the bioprocessing, we have established ourselves as the leading materials provider into that space. Our content is going to be ubiquitous across all modalities. And within a modality, if you were to break it down into kind of upstream, downstream and you'll finish your formulation, we're going to have relevant content across that entire spectrum. And we continue to advance the offering through a really robust innovation process. As part of the milestone I mentioned earlier, just in terms of the investments that we've made over the last decade to expand the infrastructure, the capabilities. We now have 13 R&D centers around the world, where we're driving this activity and the return that we're getting on those investments is just really, really terrific, as we highlighted at Investor Day. On these new modalities, just as an example. A lot of really rich opportunities there to bring new materials into the offering to help solve some of the unique challenges associated with these new modalities. There's also some really great opportunities just as regulations tighten and change around the world. One of the things that we launched this last year that we're excited about is a new material that addresses an eco-toxicity concern within the value chain that's being regulated in Europe here in a couple of years. So the team had really great capabilities. The portfolio has expanded both through innovation but as well as through the work that we've done from an M&A perspective. If you look how we've built our single-use offering and now have the only end-to-end aseptic fluid management solution in the space. So we're going to continue to invest as necessary to ensure that we're providing the right materials to solve our customers' challenges.

Maybe just 1 more there. In terms of the inventory, just what's your visibility into what your customers hold? And is it like your products sitting in inventory? Is it the drug companies and the biotech companies just sitting on finished goods inventory? Any more color on kind of the visibility and kind of where we stand right now?

Well, I think as the industry has proven over the last couple of years, there isn't really great visibility, just given some of the challenges we've had in trying to forecast the business. We try to triangulate it through a lot of different data points. And as we've been saying now for a few quarters, those data points continue to be positive and trend favorably. And I do think that from a raw material standpoint, at least we are in the last innings here of kind of getting the inventories normalized, if they haven't already. We do know that our customers are holding excess levels of their products as well, most likely at the bulk drug substance stage is where you would inventory that. And you can see it on their balance sheets, at least for the public companies that do report, and those things are certainly heading in the right direction as well. But I do think that's probably the only one standing between us and a nice recovery here, just given the number of approvals that were in the market last year, the patient demand, and that space continues to be quite healthy. So as these inventories normalize, I think we're poised for a recovery.

And maybe just one, how about 1/3 of the business that's not bioprocessing in this segment? Just what's the underlying growth rate that you expect in that business? And is that consistent with how we think '24 plays out? Or is it different?

I appreciate the question because 1 of the reasons why we did this resegmentation, not only is it the right way to run the business. But to my earlier point about helping you understand our business a little bit easier, making it easier for you to understand. Part of that is helping you understand what an attractive production platform that we do have. We've talked about bioprocessing, and that gets a lot of headlines. But there's also some other really rich franchises within there, including our new silicone franchise. Within that production segment, we're going to be the leading provider of silicone formulations into the medical implant space. The business really is well positioned there with some great technologies. It's all innovation driven. It's all customized to meet a specific customer application requirement. The business grew over 20% last year, well above kind of procedure levels. So clear indications that, that supply chain was restocking and normalizing. As anticipated, we started to see some of that pull back in Q4 and would anticipate some of that just given the comparable to work its way through this year as well. So we're anticipating that part of the business to be off, going to be somewhat flattish to maybe it's down modestly. Our semiconductor platform is another important platform that's within there. Obviously, a little bit overall modest contribution. Last year, I was getting a lot of the headlines just given how far the semiconductor space was off just given the reset that's occurred there, we would anticipate that part of the portfolio experiencing maybe some modest growth this year.

Got it. Okay. Yes. So just broadly on lab solutions, That's still 2/3 of your revenue, right? So I think you guided this year to low single-digit growth. You had declined, I believe, like mid-single, maybe last year. Just what's the right way to think about that business? And what's the visibility or confidence that investors can have in kind of a low single-digit profile?

So the Lab segment for us is definitely a run rate business. We get orders on a daily basis. And for the most part, we'll ship those within 24 to 48 hours, which kind of defines the level of visibility that we have. So similar to the overall guidance philosophy we've discussed, our outlook for that business just assumes a continuation of current run rates together with the pricing that we anticipate getting in that business, which I think we feel pretty good about. And so at that point, it just becomes somewhat mathematical looking at whatever it was last year. And so to get to a modest level of growth this year, it's really coming off the back of a little bit of impact from pricing.

And just generally, your competitive position there?

Continues to be strong. We had a really terrific year in 2023. The commercial intensity has ramped up on this platform dramatically, I would say, over the last 12 to 18 months. And we've seen meaningful signs of that. We grew our academia position last year, high single digits, low double digits, a really terrific year where we were clearly taking share another really strong year in biopharma with a lot of new customers and extensions of some important agreements there. So we continue to have confidence in the positioning a lot of investments in our digital capabilities there to make it more efficient for our customers to engage with us, minimize the time that they're spending on some of these more administrative tasks. And if I look at just some proof points there, the traffic to our sites relative to our competitors is a nice indicator for our business. And then some of the solutions that we've deployed into our customers, whether it be some of the auto replenishment tools that we've deployed, or some of the inventory management tools that we've deployed, just a lot of momentum that we have off of that platform. So we like to set up the activity is good, and we do anticipate a bit of growth this year. But long term, that's a low to mid-single-digit grower for us.

And what would you say like the strategic priorities would be on that side of the business, given it is so big, lower growth, but sticky. Like can you say here are the 3 things or 2 things or whatever they are like over the next 3 years...

Yes. No, it's a good question. And I think as we look at that segment, first of all, it gives us unparalleled access to our customers. And we leverage that access across more than 300,000 patients to see the content that ultimately gets spec'd in for our production segment. And that's an important part of that platform. But on its own, it's a great business. We think there's some opportunities to accelerate growth by focusing on the high-growth workflows that are in that space. We think there's an opportunity to continue to enhance the level of proprietary content in that platform, which will not only help with the top line, will also help with margin expansion. And we'll continue to invest aggressively, not only in the physical infrastructure to maintain the service levels that our customers will come to expect from us, but also in the digital infrastructure that can create so many efficiencies and further ingrain us in our customers' workflows.

So you've got in the U.S. a continued resolution. You open the paper, and you see like some of the European countries are in like maybe recession. But this business, I would assume the consumable business is stickier. Just any impact from those factors like in terms of some of the pressure points around the world?

No, I mean, we do run a global business. We certainly follow all the dynamics around the world and has certainly been a rather dynamic time period. But no, I think the business is navigating it well. We do like the positioning, putting the inventory stocking issues aside that we've had for the last couple of years. I think time has proven that consumables portfolio, particularly in a dynamic time, tends to fare better than the most. And given more than 85% of our revenues being recurring, a significant portion of that being spec'd in. And we like the positioning of this business. We're not going to speculate what will happen from a political standpoint. I don't -- when you look at the amount of our business that's exposed to the government, it's relatively modest. So I don't think we're particularly exposed to that particular issue. And then just some of the -- that you mentioned Europe. Again, our business has demonstrated resiliency there throughout the last couple of years and particularly in the industrial space, where there's maybe been a little less of the inventory stocking compared to what we saw maybe in the biopharma space. It definitely shows not only the power of a consumables portfolio, but the benefits of having a diversified portfolio like we have.

So kind of free cash and your guidance, I believe, is about $600, $650, and we model kind of midpoint is greater than 90% conversion. It's obviously been a big focus for you for any company. But just how do you feel satisfied with the conversion levels? And just kind of how do we look at about the ability to kind of continue to grow that cash flow?

So I think one of the really exciting attributes of this business is just how much cash it does generate. And 2023 was no exception. We ended the year in the fourth quarter with conversion over 120%. On a full year basis, it was over 100%. And that was by accident. There's certainly a fundamental bias in the business to generate a lot of cash. But we worked hard on managing working capital, both from a receivable standpoint as well as from an inventory standpoint, to get inventories in line with current demand levels, and you see that reflected in the numbers. I think we've said long term, we would anticipate entitlements north of 90%, which is the way we've guided the year, and we'll continue to be really disciplined in how we execute that plan.

And maybe leading into that. So M&A, you brought in the new leader. I don't know if it was 1 year, 1.5 years ago. Just kind of where are you? You had the 2 big deals you did or kind of announced some distances kind of passed since you did those deals. Are you ready for another deal in the near term? Kind of discuss like deleveraging versus cap al kind of versus M&A? And if you're not ready now, kind of when do you think you will be?

Yes. I think we've said that our primary focus right now is deleveraging. We paid down a significant amount of debt over $850 million last year. Leverage is still higher than we wanted. We need the denominator in that equation to start seeing some momentum. So we're squarely focused on getting less than 3x, which not likely to happen until 2025. And so we'll continue to use available cash to delever. But long term, M&A is an important part of our playbook and something that, at the right time, we would anticipate getting back.

Interesting. Maybe just 1 more back to pharm and then we'll kind of close it. But just in terms of pharm, biotech funding has picked up. I'm just wondering, like what percent of your business of these smaller biotechs and could that have any impact, maybe not immediately, but as you look at over the next 12, 24 months?

Yes. So just the way we categorize our revenues in the production segment, that is really reserved for our commercial revenues. Biotech is primarily going to be research-driven activity, which is going to be in our lab segment. At the enterprise level, it's -- we said it's kind of low single-digit exposure there.

Okay. So maybe just kind of in closing. Maybe you can either take it as what's most understood or just kind of what's the message you want to leave investors with?

I think I'd probably just go back to the transformation that we're driving. We are really excited about these 2 new segments that we've launched this new operating model. It is, I think, the right way to run this business. It will, I think, help drive accountability and performance over the long term. I think it makes it easier for investors to understand our business so to the extent that there are any misunderstandings, I think that this hopefully will help sort out some of those things. But I think it also helps uncover the true positioning and value of this platform. It really is an attractive platform that's deeply rooted in our customers' workflows. We are a leader in providing ultra-high purity solutions into some really attractive end markets like biopharma and bioprocessing. And I think there's some really meaningful opportunities to enhance growth and margin over the long term. So we're really excited about where we're at today and really confident in the future.

Great. Well, thanks, Michael. Thanks for being with us today. I appreciate it.

Thank you.