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

Thank you for joining us. My name is Mike Ryskin. I'm on the Bank of America Life Science Tools and Diagnostics team. And excited to host for our next session. We are joined by Avantor, and we have Michael Stubblefield, President and CEO with us. Michael, thanks so much for being here.

Hi, Michael, thanks for having us. We're happy to be here today.

To be the usual fireside chat. Just to kick things off, let's talk about first quarter results and how that played out. I think it came in a little bit below investor expectations. Any comments you want to make in terms of at a high level what you saw in the quarter versus your internal expectations versus your plan for the year?

I think to start, what I'd just reiterate is just our confidence in the strength and resilience of our platform. I think about our Lab Solutions segment, we have differentiated capabilities, a broad and expanding portfolio and a supply chain that enables us to serve more than 300,000 customers reliably around the world. In our bioscience production segments, we have a leading bioprocessing franchise, and we are the leading supplier of medical-grade silicone formulations. And thinking about our financial results over the -- certainly in the first quarter and even back into 2024, I think you see strong margin execution, best-in-class free cash flow conversion and earnings in line with our plans and our targets. And I think that's notable. And I think it speaks to our team's ability to execute in a relatively challenging environment. And it also underscores the impact of the structural cost actions that we have taken. On the first quarter call, we talked about some decisive actions that we're taking to stimulate our top line even in the midst of a challenging macro backdrop. Corey Walker has joined the team to lead our Lab Solutions segment, and he's leaning in aggressively to evaluate all aspects of our strategy and our execution. He's partnering very closely with our commercial teams to not only retain existing accounts, we highlighted the extension of our Regeneron contract in the quarter, but also aggressively go after new accounts in this environment. But a number of actions that have been in flight now for a couple of quarters around differentiated supply chain performance, expanding our portfolio with innovative new partners as well as investments in our digital capabilities and pricing. Those will certainly improve the top line as we move forward. And we highlighted some incremental cost actions that we've identified that will play out over the next several years.

All right. A lot to unpack there. I'll dive into those over time. But the other topic I want to touch on was the other big change announced a couple of weeks ago was the CEO transition. So I mean, at a high level, can you talk about how that decision came about? Why is now the right time? And just how do we think about that playing out?

So I've led the Avantor business now for a bit more than 11 years. And as you can imagine, the Board and I have had regular discussions around succession planning. When I think back to when I started, the business was just a bit over $400 million in revenue. We'll touch -- we have touched $7 billion here more recently. Had the privilege of leading the business through a successful IPO, orchestrating our organization to respond to the pandemic, and we're incredibly proud of the role we played there. And more recently, we have stood up a new operating model that's essentially complete. There's a lot I'd like to do both personally as well as professionally still. And so it felt like for me, it was a natural time for a transition. When I think about it from the business perspective, we've highlighted the work we're doing to look at our strategy over the long term. And I do think having a fresh perspective in that context it will be helpful for the business. And so the Board and I took a look at it and agreed that now would be a good time to announce this. It gives us a long runway for us to drive a smooth transition, and you can certainly count on me to run through the tape and continue to serve as the CEO until my successor is named.

On that long runway for the transition, how should we think about timing? How far along in the search are -- is the Board? Any indication?

Yes. So nothing really incremental to add beyond what we announced a couple of weeks ago, which is the Board has initiated a process. They've got a retained recruiter that's now been in the market for a number of weeks. Any time you announce these things, you certainly don't want to draw it out longer than it needs to be. And so I know the -- for the organization's perspective as well as our investors, I'm sure the Board will move expeditiously as they can. But certainly, we've got the benefit of time to ensure that we get the right candidate in here with the right track record and focus on growth and value creation.

You mentioned that track record. Is there anything in particular that you -- the Board is looking for, whether it's internal candidate, external candidate, industry expertise, just sort of what's the right background to be the next Avantor CEO?

Yes. So I don't want to get ahead of -- ahead of them on that, but we have a talented team internally, and we have indicated that they're also looking externally for the right leader. Given where we're at today, growth -- a growth mindset is critical, innovation background, focus on execution and delivering results and creating tangible value, I think, are all going to be important attributes of the next leader for sure.

Okay. Okay. All right. So going back to some of the macro and policy things that we talked about that have happened over the last couple of months. I want to touch on tariffs. Sort of you gave a lot of color on what the tariff exposure could be in terms of COGS to China, modest in comparison rest of the world. But -- could you talk a little bit more about your methodology or your thought process for tariff impact to Avantor this year, mitigation strategies against that and just sort of how that's being implemented over the course of the year.

So I think we could all agree that it's a dynamic situation as underscored by the announcements yesterday on U.S.-China trade agreements. So let me just clarify for how we see tariffs as we sit here today based on the agreements that are in place and the rates that are in play. Our biggest exposure is to imports from China into the U.S. We size the COGS exposure that we have on that trade lane. And based on the rates that were announced yesterday and that are now in place at least for the next 90 days. For the balance of 2025 and probably size that exposure of roughly $20 million, $25 million, somewhere in that range. More modest exposure to the rest of the world, that probably adds another $5 million or $10 million of exposure. So net-net, as we sit here today, based on the rates that are in place, I think about our exposure in that $30 million range. So if you convert that to an EPS, that's probably $0.03 to $0.04 if you were unable to mitigate any of it. Now to be very clear, we didn't incorporate any headwinds into our earnings and our updated guide because we don't think there will be any. We're incredibly confident about our ability to offset these -- these headwinds through a number of specific levers that we think are unique to Avantor. Firstly, I highlighted earlier, our broad and expanding portfolio and our global supply chain. That's where we start with our customers. That's the focus that we've had with our customers over the last number of months as this topic has evolved is trying to be very transparent with them about the goods that would be impacted by tariffs and making sure they understand what the potential alternative products would -- could be or sourcing arrangements that we would have for them to help them mitigate the exposure to the tariffs. Secondly, we have an incredibly sophisticated pricing framework and we have the flexibility within our commercial relationships. If necessary, we can certainly pass this through. That's kind of how we're friendly with our customers, quite honestly, is -- look, we have alternatives. We're being very transparent about what those alternatives will be. But if either you don't like the alternative or in the cases where there isn't an alternative if you still want to buy, here's the price that you're going to have to pay. And I think that has worked well with our customers. And now that at least for the short term here, we seem to have a little bit of clarity on how China is going to play out. I'm sure we'll be able to move forward here in the coming weeks with more specificity around is the customer ultimately going to choose an alternative product where they're okay paying the higher tariff? And then lastly, we have taken a lot of cost actions over the last couple of years, and certainly, 2025 will be another strong year of execution on that front, and that will also help offset some of the -- and help mitigate some of the impacts that we see coming from tariffs. So net-net, we don't think that we'll have any headwinds accrued to the bottom line, which is why we haven't incorporated anything there. The other side of it is on the revenue side. We think that it's likely that our imports out of the U.S. into China, which are relatively insignificant. We have essentially in the second half of the year as we've burned down that inventory. We've taken that to 0. That is reflected in our current guidance. We've not tried to speculate on what decisions our customers are going to take on whether to buy an alternative product or to pay a tariff impacted price. To the extent that they do end up paying some of the tariff impacted prices, that would be a little bit of a tailwind to the top line, but we've not tried to reflect that in our current guidance.

Okay. Just to clarify, that $30 million you talked about earlier, that's -- is that a net income number or COGS number, revenue number?

So that would be a COGS number that if unmitigated would flow through to EPS, and I gave you the range there. In the worst of cases, it would be $0.03 to $0.04. But to be very clear, we don't anticipate that. We're quite confident we can offset that.

Okay. And that's as of the yesterday new rates of 30% of China, 10%, right? 30%, 10%?

Exactly. Exactly.

Okay. And that's the biggest area that you're concerned about is U.S.-China?

So that's the bulk of it. As we highlighted on the first quarter call, that's the biggest exposure that we have. It's roughly 2% of COGS. That's about $20 million, as I said. Rest of the world is relatively smaller by comparison and maybe it's another $5 million or $10 million to get to the 30.

And when you think about -- you outlined various mitigation whether it's cost actions, alternatives, price, et cetera. As we think to 2026 and beyond, there's no reason that you should continue to be able to mitigate that. None of this is sort of temporary and you're not going to have a surprise hit next year.

No. I think we would agree with that framework. We're being very transparent with our customers on what the optionality is to the extent they choose to switch to products that will continue to flow through. If we have to put tariff surcharges in place or incorporate that into pricing and the tariffs persist into '26 then that mechanism will survive as well. So I think we feel good about the levers that we have to offset this, not only in 2025, but beyond.

Okay. Switching to the organic guide and sort of your expectations for markets for the rest of the year. You updated the fiscal year '25 guide on the call, organic sales decline of negative 1 to plus 1. Can you talk about what's implied there for BPS and bioprocessing specifically versus LSS? Just sort of what are the moving pieces there? What are the market conditions that rolled up to that new guide?

Yes. So when we put out the original guide, it was the day before some of the policy changes were announced on NIH and funding. So we didn't anticipate that as we got into the year. And obviously, that did impact how the first quarter played out. And so consistent with how we have guided last year and even coming into this year, we're not trying to call incremental downside we can't foresee. And by the same token, we're also not trying to anticipate a market recovery that we don't have line of sight to. As you know, we have from a structural standpoint, relatively little forward visibility just based on the shape of our order book, particularly in our lab segment, it's more of a book and ship type framework. So the guidance that we have now in -- on a full year basis does contemplate the rates that we were seeing as we exited first quarter persisting through the balance of the year. Similarly, on the bioscience side of things, there was a little bit of -- a couple of pockets of weakness in the first quarter that we don't think are -- you're going to play out that way on a full year basis. And so we have just applied normal seasonality to that part of the business, which means Q1 was the low point. It gets a little bit better as you move through the year. We've incorporated, obviously, the number of business days in each quarter as well as just the visibility we have on the order book itself. So the way that it plays out then at the enterprise level is about 49% of our revenues on a full year basis are in the first half, 51% during the second half, very similar to how we thought about this in previous years.

And you called out some of those pockets of weakness in the first quarter that you don't expect to continue through rest of the year. Can you expand on that?

Yes, the primary one in our Bioscience business was in the controlled environment consumables. That's a part of our bioprocessing platform that's important in maintaining the integrity of the clean rooms that these therapies and these molecules are produced in. We did see some modest levels of destocking there and inventory optimization in the quarter. Rates have improved as we've kind of moved from March into April, as we talked about on our call, and we've seen that continue to improve as we've moved into the month of May as well.

Why do you think that controlled environment consumables was experiencing that destocking? And that's something we've really talked about in the past, and it didn't really jive with anything in terms of bioprocess demand elsewhere. So it seems like a really unusual move. What do you think was driving that?

Well, a couple of things I'd say about this category. First of all, it's a staple. It's a classic pick-and-shovel kind of product for the tool space and for our customers. They can't run these clean rooms without the products and the services that we provide in that environment. They are part of our customers' SOPs. And in many cases, they're also part of the regulatory filings. It's an incredibly steady category for us. I think mid- to high single digits on a steady-state basis. In Q4 even, we drove high single-digit growth in that category. So we were certainly surprised as we got into the quarter to see order rates drop off. It wasn't widespread. It was in a handful of accounts. Where I think they made some decisions based on where they were at from an inventory standpoint that played out as a bit of a headwind for us in the quarter, but nothing that we're -- we see as structural or very widespread. And as we've monitored the rates moving from March into April and May, we see it improving each day.

So you talked about the not expecting any particular recovery nor any further weakness through the year, but your BPS guide, I think, for the year is plus mid-single digits. So it's a pretty meaningful acceleration from the first quarter. Is that really just tied to this controlled environment consumables? Is that the only difference between what you saw in 1Q versus your expectation for the rest of the year?

Yes. So our guide coming into the year was mid- to high single digits for bioprocessing and we scale that back to mid-single digits to take into account the pockets of weakness we saw in the first quarter, which we don't see persisting. We're incredibly bullish on this end market. We think the end market fundamentals are incredibly strong, approval rates of new therapies, production levels are up. Our order book now for quite a number of quarters, even going well back into last year, continue to outpace our revenues and we saw that in Q1. We see that order book strength continuing in the second quarter as well. So it's plus or minus operating normally at this level. And we think that when you just look at the fundamentals, broadly speaking, we're not concerned about the ingredients and single-use side of this business continuing to run at these rates. We talked about coming into the year, Q1 is the low point from a seasonality standpoint, and we'll see more business days and things as we move into the rest of the year, even the second quarter, you'll see a meaningful step-up here sequentially just based off of those seasonality factors and business days. But the order book is very, very strong. And I think we're quite confident about the outlook of that platform for 2025 and beyond.

And you just touched on the order book. It sounds like visibility remains pretty solid. Is there really, besides what we talked about in the controlled environment, any sign that bioprocessing is now sort of back to normal operating environment? It's been very choppy last couple of years.

So lead times for our platform are roughly 2 to 3 months, and that's been in place now for well over a year as supply chains have normalized. So we've seen order patterns for our customers as destocking has essentially been eliminated, return to normal in terms of they're providing new orders, respecting your lead times. And so when we think about visibility in that business, it's current quarter, as we sit here in the middle of May, we're starting to see orders flow into the third quarter as well. And we look at it on a daily basis and orders continue to outpace revenues as we move forward here. So visibility is within at least in that context of our lead times, continues to be good and the fundamentals continue to be quite strong.

Yes. The other question we've got on bioprocessing and maybe this could be a broader pharma consumables or even A&G consumables question was, could there have been some pull forward in the first quarter from customers looking to get ahead of tariff hits? Whether it's pharma or CDMO, trying to stockpile more finished drug or even work-in-progress reagents, just to be able to relocate them to the U.S. to get ahead of tariffs, imports from Ireland and things like that. Did you see any indication that there was any unusual order timing or patterns from your major customers?

So I think the experience of COVID certainly taught us to say -- never say never. But we don't really have any indications that there was any pull forward. We watch these order rates daily. We see shipping patterns, and there was really nothing that has stood out to us. And even when you look at moving from Q4 into Q1 at both a product category level or a customer level. I think from what we can see, nothing stood out to us as unusual and none of the analytics that we run have also haven't flagged anything that would -- that has caught our attention.

Okay. Moving to some of the other end markets and maybe customer groups. I want to talk about within LSS, especially more of the traditional distribution side of the business, sort of the legacy VWR some of that portfolio, the more commoditized products. How do you feel like the competitive landscape and the share gains and share losses have gone in that market? There's always a little bit of tension between you and the other large distributor in the tool space. So just have you noticed any change in that environment?

So I'd say a few things here. Firstly, we've highlighted and we've talked a lot about the macro environment and the impact of some of the policy changes around NIH funding, which has impacted our academic and government sector, Some of the market or capital market-related headwinds around biotech and then just some of the inflationary and GDP-driven headwinds impacting some of the other end markets. That -- the fact that the growth has been more challenging to come by has created a more competitive environment, I would say, just broadly speaking. And it's important to note that it's not just a duopoly here. It is a very fragmented space. Yes, there are 2 large players in this space, but there's also quite a number of important smaller regional players that are critical to meeting the collective needs of these end markets. When we look at how these competitive dynamics are playing out at an account level, we see a few different things happening. We highlighted at least at a handful of accounts, some shifting of -- within categories at some of these accounts. But we also noted quite a number of new account wins and extensions. So the -- I would say the bar for our customers or potential customers to consider new suppliers has probably been lowered, just given the macro environment. And when that plays out at your customer, it can be a little bit painful. But on the other hand, we see it as a significant opportunity for us as well to go into accounts where maybe we haven't historically had such a strong presence. And so flipping then to the actions that we announced, I think it puts a spotlight on how important that is and how bullish we are about the impact of the actions. We have an incredibly strong platform. We're extremely well positioned with a great portfolio, a great supply chain, and we can provide an incredible set of services to this marketplace. And so under Corey's leadership, he and the team are leaning in aggressively to drive activity at the account level, both to defend existing business as well as to go after new business. And when we think about the second quarter, we think there'll be some -- certainly incorporated into the guide is continuation of the current market conditions, but we anticipate being somewhere in that low single digit to flat range and with the actions that we're taking, we see the opportunity here to drive some upside over time.

Okay. You touched on these things in a couple of different areas, but I want to ask about academic and government, maybe tie that into the instrument side of the portfolio. Obviously, a lot of weakness there from U.S. policy, NIH cuts, things like that. Remind us sort of what your exposure is to U.S. academic and government, U.S. NIH, what your expectation is for the rest of the year from that customer group?

So it's about 5% of our enterprise revenues are linked to the higher education in the U.S. region. And as I mentioned earlier, the policy changes and funding changes that were announced happened to come out the day after we made our full year guidance. We didn't have the opportunity to take that into account. The environment shortly thereafter those announcements turn decisively cautionary. And when we look at an individual university account, it probably impacted them in 2 or 3 specific ways. Firstly, I think very naturally, broad movement to preserve cash and optimize cash. And the easiest way to do that is to pull back on capital spending. And so you're not there to -- equipment and instrument softness comes from that dynamic of just preserving the cash that you've got in an uncertain funding environment. We also saw either a freeze or a pullback in hiring, which in a consumables-driven model like Avantor has, we're an activity-driven business, meaning we need the lights to be on. We need scientists and labs doing research. That's an important part of the growth algorithm. So a pullback in hiring or even layoffs can be a bit detrimental and it ultimately leads to fewer new programs getting started, which is an important part of the model. And that does bring in the breadth of the portfolio, not just equipment and instruments, but also consumables. So we saw general weakness across the board and it happened pretty quickly after some of these changes were announced. And so we've seen it stable from February, March, April into May. We haven't really seen much change once we saw that initial step down. And so those rates have been factored into the outlook that we updated at the end of -- as part of our first quarter call.

So for A&G and U.S. A&G for the rest of the year, you're essentially assuming what you saw in March, April continues at that level throughout?

We are.

Okay. All right.

No additional deterioration and conversely, no upside either.

I want to talk a little bit about the cost actions you've announced both more recently, just over the last couple of years. You've expanded your cost savings plan to $400 million exiting 2027. Just sort of where are the areas where you're able to take out the most cost? And how do you balance that between sort of staying nimble in this environment and making sure you're not cutting too far?

So a couple of things, I think, to highlight here. Firstly, this has been an important aspect of us being able to deliver on our margin, cash flow and profitability targets last year as well as in the first quarter, and it does underscore I think the team's ability to execute. We announced the original $300 million program in connection with the new operating model, and there were a lot of costs that just fell out of the model when you went from 3 regions to just 2 business units. You take Brent's finance function, for example, you no longer had 3 reporting segments and now just 2. And so you're able to cut proportionately. And that played out really across the organization. Coming off a number of years of high inflation, the procurement lever has been a really solid contributor to our targets over the last couple of years. And then we have made significant investments in our business. The last 2 or 3 years have all been record levels of investments in footprint, optimizations, and expansions, investments in digitization, robotics, automation to help combat some of the inflationary factors that we see. Then did enable significant rooftop consolidation and footprint optimization. We call the transformation for a reason and why it was playing out initially over a 3-year period and now as we've expanded it, we've added another year to the program. We're making significant investments to change the way work is getting done to make it sustainable. All the while we continue to invest at record levels to continue to grow the business and position us for sustained growth over the long term.

On the topic of some of those cost outs, you previously talked about a 20% or greater than 20% EBITDA margin sort of longer term exit rate once some of the market uncertainty dies down. If anything, I think we've probably seen more market uncertainty since then. So how would you characterize your thoughts about that long-term margin opportunity and the road map to get there?

Yes. So a couple of things. Firstly, the target of exceeding 20% is not really aspirational. We've run at those levels before. And this is a really important part of the Avantor story is our ability to drive margin expansion with price over COGS performance each year, growing proprietary content, growth of our bioscience production segment is a nice contributor to margin expansion. And then of course, the cost actions that -- what we're taking. But we do have a significant footprint that in an environment where volumes are contracting can be pretty punitive. And that's what you've seen over the last couple of years. So volume growth is an important part of the story here. And we said coming into the year that we were targeting to exit at 20% or taking into account our clinical services divestiture of 19.6% on an adjusted basis, we expected to exit at those rates this year and said that we could get most of the way there based on the self-help actions that we've been driving, but that we did need to see some market recovery to help offset some of the absorption. Clearly, things have turned more cautionary since -- since we got into the year. And so as we've updated our margin guide for the year, I think our -- we're centered on 18. We'll see where we get on an exit rate, but not likely to be in at mid-19s. But over the long term, whether that's in '26 or '27 as these markets normalize, I think the margin expansion part of the story is going to be an important one.

Okay. We're almost out of time, so maybe just a quick closing question, Michael, as you look back at your lengthy tenure at Avantor, just sort of what do you think is still most underappreciated or misunderstood about the business?

Look, the platform has come a long way. I highlighted where it was at when I started and kind of where we sit here today. There's a lot still to be done here. I would just reiterate our confidence in not only the strength but also the resilience of the platform, its positioning. And when I look at the segments and the capabilities that we have, the market needs a strong Avantor, both in the lab as well as in the production environment. We have a terrific portfolio, supply chain that allows us to deliver to our customers with confidence. We're doing all the right things to drive top line growth, and the team is incredibly introspective and working hard to tweak the strategy to ensure that even in a macro environment like we're in, that you can still drive top line momentum. And of course, we are doing all the right things to continue to make the business more productive with the self-help cost actions that we're taking.

Great. And with that, thanks, everyone, for joining us. We're out of time. Michael, thank you. It's been a pleasure.

Thank you.