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

Good morning, everyone. Thanks for joining us this morning. My name is Matt Sykes, the life science tools and diagnostics analyst at Goldman, and I have the pleasure of welcoming Michael Stubblefield, President and CEO of Avantor. Michael, thanks for joining.

Yes, Matt, thanks for having us. Happy to be here.

Great. Maybe if we just start out, if you can set the stage a little bit. Q1 came in line with your expectations, and we're kind of most of the way through Q2. Maybe just talk about how underlying market conditions have changed and what you're seeing today and sort of versus kind of what you're expecting for the full year and the trends that you're expecting to see?

I think it's a good place to start, Matt. When we come into the year, maybe just to set the context for how we've guided the year given the kind of the structural visibility we have in our business, we essentially guided based on a continuation of the trends we saw in Q4. So similar run rates in both our lab and our production segments, extrapolated on a full year basis led to the numbers that we have out there. And Q1, as you suggested, came in generally in line with that model, consumables in both the lab and the production environment were a bit better than the rates that we came into the year with. Equipment and Instruments declined pretty meaningfully in the quarter and net-net, the two roughly offset each other. So that's kind of how the quarter played out and was in line with our plan for the quarter. And so with the visibility that we have, I don't have a different view to call on the second half of the year. We're anticipating a continuation of current rates. But if something changes to the good that could potentially give us a bit of upside in the back half.

Got it. As you -- I mean, visibility has been a common topic. And maybe can you talk about the evolution of visibility that you've seen over the course of the end of last year coming into this year? And kind of what would it take for you to sort of call that inflection in terms of the visibility that you've got?

So in our business, probably not unlike a lot of others, visibility is really dictated by the lead times in our supply chain and our order book. And the dynamics are a little bit different in the two segments that we run. In our lab segment, which is largely a book-and-ship type business where my supply chain is capable of reaching our customers in a 24- to 48-hour period. Orders are coming in and going out, essentially real time, and that's kind of the level of visibility that we have in that part of the business. Similarly, on the production side of the business as things have normalized coming out of the pandemic, our supply chain has reset. And we're working off of lead times and order books that are roughly 2 to 3 months which is similar to what we had going into the pandemic back in 2019. So we have a bit more visibility there, but not substantially more. And so that's the kind of the defining elements of how we are able to look into the future there. So in lab, a few days to a week, on the production side a few months. I would say relative to last year or this year, the visibility hasn't really changed structurally. I would say, as the supply chains have proved, things have kind of reset to the way they ran prior to the pandemic though.

Got it. And just kind of keeping a high level for a minute. Just given the experience you have in the industry, it would be great to get your perspective on the recent downturn in the industry and what you see as potential structural changes versus purely cyclical in terms of end market demand and customer behavior?

Well, it's certainly been the most unusual time for our industry, both the highs and lows around the pandemic and then the reset that we're -- the industry is going through coming out of the pandemic, certainly wouldn't characterize it as a normal environment, and we're still as an industry working our way through that. But I'm not sure I would say that you could point to any structural change in the end markets. At the end of the day, there's never been a more exciting time to be serving science. When I look at what's going on from a pipeline perspective that's driving R&D activities across legacy modalities, monoclonals, there's still a lot of excitement there. There was obviously some approvals that were pretty exciting earlier in the week around Alzheimer's in the area. There are some advancements around antibody drug conjugates that are going to make monoclonals relevant for a long time. And then you have a new modality, cell and gene therapy, picking up a lot of traction, mRNA, GLP-1s and others. So the science is good -- great. A lot of opportunities to bring indications to market to treat diseases that we haven't been able to treat before. Obviously, there's some near-term dynamics that are making things a bit sluggish. But the fundamentals, I think, are intact that would drive, spend in the R&D area long term to chase these opportunities. And then certainly, the inpatient demand is clearly there. So from our perspective, it is a bit of an unusual time and certainly a dynamic time, but nothing that I would point to structurally change.

Got it. You mentioned earlier, you commented previously your guidance for the year based on continuation of current market conditions. But based on what you've seen through the year thus far, are there any areas you see a potential improvement driving upside to that negative [ 2 ] to plus 1 range for the year. I think what we're trying to get at is sort of what are the deltas -- like what are the potential upside situations, what are the potential downside situations within that guidance range?

Yes. So just to reiterate, again, the outlook is based on a continuation of trends that we saw exiting the year. There were some differences in Q1 relative to that equipment and instruments got weaker than planned. I think we were down about 10% sequentially moving from Q4 to Q1. Largely able to offset that with strength in lab consumables or a better-than-planned performance in lab consumables and bioprocessing did a bit better than planned as well. But none of that, at least on the consumables side, I would put into the category of an inflection point or a full recovery. They were modest and fortunately, of a magnitude that we're able to largely offset the headwinds that we faced on the equipment side of things. But I think the expectation just based on the visibility that we discussed earlier is that those trends persist until we are able to see an inflection point, which in our mind would be defined by -- there'll certainly be a duration element to that. We certainly wouldn't be looking for a bounce back on a week or 2. We'd want to see it over a period of time and at a material level of difference in terms of order intakes and revenue generation. So we haven't seen anything like that yet in -- as we move through the first quarter. And we talked a little bit about April on our earnings call and certainly what we saw in April fed into what we indicated for the second quarter. So continuation of current trends, I think, is the base plan to the extent that there was any meaningful recovery in the back half of the year, as I said earlier, that would be upside.

Got it. And then just given some of the areas of your business are shorter cycle in nature, just how quickly have you seen demand bounce back in those businesses historically from previous downturns? And kind of what is your expectation for some of the shorter cycle nature parts of your business?

Yes. So to be fair, I don't think any of us have ever seen a dynamic like we've experienced here. So I'm not sure there's a great precedent to draw from here. But I think from my perspective, we're going to see it pretty real time. Just going back to the discussion we had on visibility. The lab business being largely a consumables driven business as activity levels pick up in a lab, we see it generally, given where inventory levels are at now having largely normalized, we're going to see that largely real time. On the production side of the business, again, we do see movements within a quarter given the 2- to 3-month lead time that we talked about. And there are some proof points to this. In Q4, we signaled that we saw a modest uptick in bioprocessing order rates, certainly not characterizing an inflection point by any means. And as we got into Q1, we did outperform our expectations on bioprocessing, modestly again, but starting to see some of that pickup in orders from Q4 bleed into the quarter, some of the improvements in Q1 order rates pick up -- get picked up in the quarter as well, all within that kind of modest category. But I think it's a good proof point, though, for you in terms of as things happen, we're going to see it relatively real time.

Got it. And from an end market perspective, you highlighted some positive developments in academic last quarter. Any updates there or maybe any distinction between different end markets?

Yes. If we talk about our lab segment, starting with biopharma, which is the majority of our exposure there. I think the year so far has been characterized by a continuation of the cautious spending behavior that we saw emerging, largely speaking, in the second quarter of last year, relatively stable as we move through the year. But that same kind of cautious approach to project spend, cautious management of cash and budgets continuing through the early parts of the year here. You mentioned the academic and government segment. Overall, the segment was down in the quarter, but the bright spot within that segment certainly is our higher ed exposure. I think we've had 5 or so straight quarters of growth in the higher ed space, which follows a real deliberate ramp in commercial intensity in that space. And we're certainly seeing activity levels as well as the impact of the commercial efforts that we're making to grow that part of the business. And then the diagnostics piece within health care within the lab, I would say, has largely normalized. Inventories are, I would say, kind of in [indiscernible] rest of the supply chain destocking largely over some pockets of [indiscernible] come back into line there. So -- and then you have -- within the advanced technology space, the QA/QC test [indiscernible]. I think that space has to probably follow historical trends a lot more closely than maybe what we've seen in some of these other end markets and I think definitely shows the resilience of consumables-driven portfolio. On the production side, we've talked a bit about bioprocessing. The health care exposure we have within production is rather unique. This is our formulated silicones offering for medical implantable devices. Last year, the platform grew around 20% or so which was a reflection of good procedure demand, but also kind of a known and deliberate strategy by both us and our customers to restock their supply chains. So we grew well ahead of demand last year. And so we knew that, that was setting us up for kind of flattish demand this year. We did a little bit better than that in Q1. But that's -- I would say the end market is healthy. We've got a unique dynamic just based on how the supply chain has been running over the last couple of years. But we like to have an awful lot, and the end market is pretty healthy. And then you have the semi and aerospace and defense exposure on the production space. Aerospace and defense continues to be pretty good for us. In semis, return to growth this year, probably not as strongly as any of us would hope. But it's small enough and it's performing at a level now that we probably won't have to talk about that too much. It's certainly not off 70% or 80% like it was last year. So...

Just drilling down in the bioprocessing end market. How is your portfolio differentiated from peers? And where are you best positioned in terms of drug type or modality?

So our platform is characterized by being a leading supplier of ultra-high purity materials, process ingredients, buffers, excipients, chromatography resins. And then, of course, we have the only end-to-end fully integrated aseptic fluid management solution in the industry as well. And so we're primarily going to be focused on the flow of liquid biological materials through the process as opposed to equipment -- large equipment installations, for example -- and we're going to be exposed across all modalities. Our content is found in upstream, downstream, full finish, across monoclonal certainly, which is driving the bulk of our revenue and that of the industries, but we're also relevant in all the commercial gene therapies that are on the market [indiscernible] exposure in mRNAs during [indiscernible]. GLP-1 isn't a huge driver for anybody in the tools space, but probably a bit more relevant for us than most, given the chemical portfolio we have that's relevant in the synthetic route as well as this ingredients portfolio that's relevant in the fermentation route as well. So going to be pervasive across all the modalities and from a therapeutic perspective, we're agnostic there. Whether it's oncology or neurodegenerative, cardiac, whatever happens to be in these modalities we're going to be very broadly exposed. I think we're 85-plus percent specced into the commercial platforms across the space today and very well exposed across the pipelines and all these modalities. So it's a rather unique business where we differentiate ourselves, not only with the breadth of this materials offering where we would be the #1 or #2 player in virtually everything that we do. But a pretty extensive footprint, having GMP capabilities in all 3 regions of the world is a pretty big differentiator for us. And then you really can't be in this space and do the things we do without having really sophisticated quality and regulatory expertise that we're able to offer to our customers to help them with the regulatory process as well. So a pretty differentiated model and it's not lost on us that there's a lot of larger players that are in these end markets. But for the most part, we don't view them as competitors in what we do, and we've been able to carve out a rather strong niche for ourselves here as a differentiated material supplier to this space.

If I can slip another one on GLP-1, the potential for oral in GLP-1 given the level of API that's needed for those oral drugs. Is that a sort of could be a potential tailwind for Avantor given the buffers and things that you supply into that?

Yes. I mean, from our standpoint, right, anything that drives volume across these modalities is going to be good for our business. I like that we're not over-indexed to any particular therapeutic indication. But volume is good and certainly the impact that it has on patients is helpful to the extent that oral drive better compliance and it's easier to administer and that leads to more volume. Certainly, that would be a bit of a tailwind to the business. But it probably doesn't change the algorithm. I mean, the thing I like about this business is, given the positioning here, the consumables orientation of the platform and in bioprocessing, 95-plus percent of what we do is going to be consumables and the balance being, some systems that we would engineer or the peristaltic pumps that we would sell as part of our aseptic fluid management solution would be that 5% piece. But being a consumables player in this space where we're going to be a relatively insignificant part of our customers' cost structures makes it a pretty attractive place for us to play. It's extremely sticky, highly recurring. We're going to be part of our customers' filings and with the footprint and the other elements of the model that I described, this is a model that has enabled us to outgrow the broader market, at least the 10 years that I've been here by 300 to 400 basis points consistently. And that happens because of the innovation of things that we do like GLP-1s that when you add them all together, it helps us build a pretty attractive platform.

Got it. You mentioned the consumables strength that you've kind of seen in that business and the majority of that business. Any way we can kind of drill down a little bit into the areas of strength you're seeing within the consumables that are kind of better than others at this stage?

So at the enterprise level, like I said earlier, about 85% of what we do is going to be consumables or services oriented. About -- in the lab. I think we've talked about 20% or so of the revenues being equipment and instruments, so 80% being more consumables oriented. And then in the production side, like I said, it's 95-plus percent consumables. And in the first quarter, we talked a little bit about consumables momentum or at least above plan performance. It certainly wasn't an inflection yet, but a bit stronger performance on consumables in both the lab segment as well as in bioprocessing.

Got it. You guys have been particularly helpful in the inventory overhang issue with the quarterly surveys you're doing with customers and things. So it seems like we're sort of the tail end of the destocking headwinds now. Are you seeing more normalized order patterns? Or are there areas that are still more of a headwind? Is it a product by product kind of issue at this point? And kind of where are we in that stage?

Yes. We would definitely agree that we are in the late innings stocking phenomenon on the raw materials. And I think we've characterized it as -- there are a few pockets that would be customer and product specific, but most customers for raw materials, I think, have largely reset and would be matching the orders with demand. The piece that we don't have as good a visibility to and something that we think is still largely responsible for the friction we're seeing in the system on the production side of things is the bulk drug substance inventories. That's not reported uniquely. It's not something that's shared with us. When you look at our customers who are public into their balance sheets, you can see elevated levels of finished goods inventory or WIP. And so we know that it's there. It is coming down, but it does still appear to be elevated. And I think from our perspective, when you look at kind of the equation driving demand in bioprocessing, patient demand is as strong as ever. You're seeing kind of record levels of approvals for multiple years in a row of new therapies coming into the market. And so in between those two endpoints, you had excess raw material inventory, which, to your question, we think is largely behind us with a few exceptions, and then you have this bulk drug substance. So order rates picked up for a couple of quarters in a row there, and certainly, the leading indicators are positive. I think our view on the structural integrity of the [indiscernible] bullish long term, just how quickly can we get through some of this final inventory on the bulk drug substance side.

On the instrumentation, which I know is not a large part of your business, but you had mentioned earlier that it was -- came in a little bit below expectations for Q1. Clearly, a big debate within the sector right now. Kind of how are you seeing that instrumentation play out over the course of this year? How are you -- how is it embedded in your guide? And what are the puts and takes, do you think in terms of seeing a potential recovery in instrumentation?

Yes. So just to reiterate what I said earlier, we had anticipated instruments in 2024 being largely at the rate that we exited '24 -- '23 at. Unfortunately, it deteriorated about 10% as we move from Q4 to Q1. We were able to offset that largely with better consumables demand. But it doesn't tell the whole story. We have this kind of in the lab side of our business. We have this book and ship type model that we described earlier. But the one piece of it where there is a lot of RFQ activity and funnel management and such is really on the equipment and instrument side of the business. And where our sellers are active in all of our customer shops trying to understand their projects, their replacements and what opportunities there might be. And the funnels that come out of that opportunity generation actually pretty robust in Q1. And so there was a disconnect between what we're seeing in terms of orders and revenue with activity and certainly the bids and the funnels that we were tracking. And our sales reps actually throughout most of the quarter, we're actually pretty bullish about being able to deliver on their plan. And it wasn't until late in the quarter when there just wasn't enough days on the calendar to deliver the numbers that they started to indicate things we're pushing. So kind of consistent with what I said earlier about biopharma activity levels being reasonably okay, but a more cautious approach to spend is leading to longer conversion cycles, a longer sales process and just a more constrained environment. So good activity. The funnels are actually reasonably healthy. But it reminds me a little bit about the dynamic we had last year when we started talking about the leading indicators in single-use being engineering drawings. And we had kind of a historical model that said, hey, when you're working on a drawing, it typically takes so much time to convert that to an order and then so much time to build it and convert it to revenue. And of course, that model ended up getting elongated. And we didn't start to see the fruits of that indicator coming into the market until some of the uptick that we saw in Q4. So there's definitely a longer cycle. The activity level is probably better than what the underlying numbers do indicate, but we don't have a lot of visibility as to when does that normalize. And so we'll continue to forecast based on current run rates.

Got it. You saw some margin benefits in Q1 as you unlock synergies from the new business segmentation. Can you talk a little bit about the continued developments there and the additional benefits you're looking to achieve across the business with this revenue segmentation?

So it is a pretty exciting time in the business to be transitioning from a regional structure to this two business unit structure of lab and production. It's something I wanted to do for a while, and we had to make some pretty significant investments in the data architecture to enable us to run the business this way. But it is a natural evolution of the business. And I think strategically is the right way to think about the business. It's -- it leverages the strengths that we have in the lab and in production. It's a better alignment with our customers. And one of the things I like about it is it gives much clear line of sight to performance, accountability and certainly a much more streamlined way to run the business. And then from a margin perspective, as you suggest, in a very unique way, it unlocked roughly $300 million of EBITDA synergies that we'll capture over the course of the next few years. The expectation for 2024 is that we would realize in year $75 million of benefit. And largely, we had planned for that to come Q2 to Q4. We were able to pull a little bit of that into Q1, which was one of the drivers for some of the margin upside that we saw in the quarter.

Got it. Just touching on the cost savings initiative that you guys kicked off. It sounds like you're off to a strong start this year with expectations for even more improvements into '25 and '26. Just any updates on the progress of the cost-cutting initiative and sort of expectations for this year?

Yes. So again, we're on track to deliver the [ 75 ]. I don't think we've read too much into it that we were able to pull some of it into Q1. The complex program, it's calling a transformation for a reason. There's 4 work streams that we're driving. There's a lot of actions and activities underneath each one of those, and there's still a lot of things that we need to do this year to deliver the [ 75 ]. And the run rate that we'd exit the year with will be plus or minus half of the target here and even just in the first year. So definitely out of the gate strong. I think we've got a good structure. Brent is -- point for us on leading that activity. And we've got a pretty significant part of the organization wrapped into driving the activities under those 4 work streams. And so it's -- but it comes with kind of a mix of some head count falling out just moving from 3 segments to 2, which is maybe some of the more straightforward parts of it. But then there's other parts that get enabled through investments in automation and robotics and facilities that allow you to take work out, investments in digital capabilities that allow you to optimize your go-to-market structure. So the approach here is really driven by the desire to run the business differently and not just temporarily take cost out now to have to add it all back just to support the business as it grows. The model should be scalable because of the way we're fundamentally changing the way the work gets done in the business. And so it will structurally reset the cost base for the business. And as we get the traditional impact of price over COGS and the mix benefits and the operational leverage as the business starts to grow again, the incremental margin should be pretty impressive.

Yes. Just following up on that. I mean you've done the structural cost improvements, so you're continuing to do them, but it's being masked by a lower volume environment. And so maybe help us contextualize what that cost structure could look like versus what Avantor was maybe pre-COVID or the appropriate time, just so that we can understand the additional operating leverage that you're achieving.

Yes, it's a great point because we are upside down at the moment. When we think about the key margin drivers for our business, price over COGS is certainly one of those. And I would say throughout the pandemic and even in 2024, that traditional spread that we target there, we've been getting that even this year. And so you kind of check the box on that one. Mix is an important driver of margin expansion for us over time. And given the mix of proprietary content in the portfolio and the growth rate associated with that, we get an actual lift in margins when that mix is favorable to us. In an environment where bioprocessing is light where the new sale business is lighter given the supply chain reset, where semiconductors are still light. You've got the margin, the mix is upside down on us. And then the last piece is the operational leverage. To be able to take orders and ship them within a 24-hour period and get them to your customers, you've got a pretty heavy model with many distribution centers as we have and the 5,000 commercial associates that we have running the model to drive the demand. We get great leverage when we grow. And conversely, we've seen the flip side of that as volumes have contracted. You've seen how fast margins have come down. And so -- we think we're on the road to -- price over COGS is fine. We think we're on the road to mix restoring as bioprocessing comes back. And then once you get growth across the portfolio, including the lab, you'll get the contribution of much better absorption. And then you layer on top of all that, the $300 million cost out that we're driving here. And we've talked about exiting 2025 with margins north of 20%. And the thing I like about this transformation program is, A, it structurally sets my business on a much stronger footing for the long term. But in the near term, while we're working through some of the industry headwinds that underpins our ability to get to this kind of north of 20% by the end of next year without a meaningful market recovery. So kind of carrying on this theme of leaning in hard to protect the growth where it exists, but controlling the factors that we can control to strengthen the business during this time.

Got it. And now for the unfair question, is your balancing cutting costs? Are you prepared to ramp up activity as volumes return?

Yes. So maybe you can take a couple of different approaches to how you manage the cost in an environment like this. You could just take a straight head count reduction, which does probably limit your ability to grow as it returns or at least puts more friction in the system versus approach that we're trying to take here, which is, look, this -- we think this model that we're standing up here works well in this environment as well as in a stronger growth environment. And so we talk about investments in facilities to drive automation. Those not only help with the cost structure, but they also help unlock capacity, particularly when volumes are growing. We've been investing significantly even in this year in a lot of our digital capabilities, which we think are core to our growth engine. And innovation is a really important part of our business. We've got 13 innovation centers that we're running around the world. Our innovation spend continues to grow year-over-year. And in a couple of months here, we'll cut the ribbon on our flagship center in New Jersey, which will double our footprint in that region. So we continue to fuel the growth investments that we -- which we think are necessary to position us to capture the growth as it materializes. And I think that's consistent with our view that you asked a question earlier about the -- we have a view that things have structurally changed in these end markets? And the answer to that is no. And there's maybe some sort of friction in the system at the moment. But there's nothing here that tells us that the model has changed. And so we're continuing to stay the course with our growth strategy. And when these markets recover, we'll certainly be well prepared to capture it.

The proprietary mix shift has been an important part of the story and adding in those proprietary products to boost margins over time. We often get a lot of questions on the portfolio of proprietary products and kind of what true level of differentiation these products have in the market. Could you give us a little more detail on sort of on the proprietary portfolio, maybe some examples of products that are truly differentiated?

Yes. It's a really good question. So I think right now, it's probably around 55% of the portfolio or so is proprietary and that will grow over time organically. Just given how much of our production content is proprietary and the fact that production environments -- production demand grows faster than an R&D environment. That will just kind of ratchet up over time incrementally. And then once we're able to get back to M&A, you can also move the needle as you deploy capital to buy proprietary technologies. And so it will be an important driver of not only just making sure that we have the right technologies to service our customers, but also it will be an important driver of margin over time. I mentioned a little bit about the innovation work that we do at these 13 centers around the world. This is an important focus for us. We've put in place a scientific advisory board, and we've launched a Science and Technology Committee on our Board. We've got a pretty high cadence around managing the innovation activities. We had an innovation council review yesterday, in fact and looking at the pipelines across all of the businesses that we're investing in. And there is a lot of exciting things going on. When I look at the work we're doing in gene therapy. We are in the midst of launching GMP, Cell Lysis Solutions. We're in the midst of launching GMP, endonuclease solutions. We innovated a new viral and activation solution for the mAbs space that we've launched that addresses a sustainability issue that's rather problematic to the space. My whole new cell platform is one of innovation. We're going to have anywhere from 500, 600, 700 projects ongoing at any particular time, working on leading-edge medical implants. So lots of examples of innovation. And I think the proof point and the real differentiation comes then in the specifications that you earn. On our proprietary content in the production environment. more than 90% of that is going to be specced into our customers' approved process, which makes it rather sticky. So we think we've got a differentiated portfolio. We think we offer a unique value proposition to our customers. And ultimately, that results in these specifications that drive the recurring revenue that we like on these models.

Got it. And then a bit of time we have left, I can't let you go without talking about biosecure. The potential impact you could see to your business, given your footprint outside of Asia, how do you think that could impact shares?

Yes. I think we'd probably say a couple of 2, 3 things about it. One, it is a topic that we have discussion with our customers. We are where they're concerned about it leaning in to try to help them understand the options to try to mitigate anything that comes from that. To the extent that there are restrictions that are placed on the CMOs coming out of China, this is where a global footprint like ours can really help provide solutions to our customers. So I don't think we don't obviously know ultimately where it's going to land, but we are active with our customers kind of working through optionality and leveraging our footprint to be able to address the risks that our customers might have.

Got it. Michael, thank you very much. Really appreciate you being here.

All right. Thanks for the time.