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

I'm Conor McNamara, the life science tools and diagnostics analyst for RBC. It's my pleasure to introduce Brent Jones, the CFO of Avantor. Welcome. Thank you for being here. Now just ahead of this fireside chat, the company did issue some new slides, which are available on the webcast for those at home on the company website. And for those of you in the room, the print outs are there. Brent is going to walk through those slides just to kick things off, and then we're going to go to fireside chat. So Brent, I'll kick it off to you.

Perfect. Conor, thanks for having me. And as you've seen, the slides are available in the room in front of you. After our last earnings, we've gotten a bunch of questions on different aspects of the bioscience production segment. So we thought it made sense to provide some additional color on that. So that's the purpose of the slides. Slide 2, we have the standard forward-looking GAAP disclaimer, all that, that we need to have. But if you go to Slide 3, let's level set on what are our segments there to put in context. So we have Lab Solutions, which constitutes our -- which constitutes lab specialty products, advanced services and our total site solutions. That's a comprehensive portfolio of high-quality lab consumables, equipment, services and digital solutions. It's our largest segment. It represents about 2/3 of our revenue and just over half of our adjusted operating income. The other segment, which is really the focus today is bioscience production, that's mission-critical, high purity materials and solutions, particularly in highly regulated environments. That's about 1/3 of our revenues and just under half of our adjusted operating income. So let's double-click on bioscience production going to Slide 4. Three pieces of that business broadly, I think important aspects at the beginning there, highly recurring revenue, regulatory and quality expertise, it's critical to our customers there, and very frequently and tightly regulated markets. 75% of this content is proprietary. And previously, we've talked about this on an end market basis. Here, we're talking about it on a product perspective because we think that provides additional insight. Now breaking that down, 2/3 of the segment, 67% is bioprocessing. There you have process ingredients and excipients, single-use solutions and then control environment consumables. Silicones, which we've spoken of frequently, it's our new sale ultra-high purity medical and aerospace grade silicone formulations. And then finally, applied solutions, and that's a combination of our electronic materials business, proprietary chemicals that go into health care and pharma applications but not in production environments. And then finally, chemicals and PPE that are used in industrial applications. Important to recognize here, this is a very high-margin segment, as you see by the operating income contribution. Generally, these are highly recurring revenue and very attractive growth profiles in these end markets. And not only that, we have strong entitlements against them, and particularly when you think of obviously bioproduction, the number of approvals and throughput there. Going to Slide 5, let's double-click and bioproduction. So we indicate here the whole production workflow. So upstream, downstream formulation and final fill. So 3 categories: process, ingredients and excipients, that's 44% of revenue that ranges in the upstream from activation of cell culture media to the downstream, buffers, salts, viral and activation solution. And then finally, formulation fill and finish our excipients, which are so critical to that. Single use systems, 26% of revenue. That's everything from our end-to-end fluid handling solution that we believe is a real differentiator for us. Other single-use 2D and 3D bags, connectors, tubing, system solutions, hydration, exactly what you'd expect of a broad single-use portfolio. And then finally, control environment consumables. Now this is really support for clean rooms and clean rooms go across all the workflows here. They're completely integrated with the production workflow and this piece of the business includes PPE, chemicals and other sterilization products that are critical to ensuring that the clean rooms can operate the way they're intended to. And look, in summary, the fundamentals of this business continue to be very strong. These are 2 segments that have a common customer base. We're taking actions to strengthen them as we've talked about, and the whole focus here is driving value creation, not only in the near term but in the long term. So...

Great. Thanks for that, Brent. We really appreciate the clarity. I think this is incredibly helpful. As we've gotten questions from investors, I think there's been a little bit of confusion on the bioproduction side. So this -- I think clarity is always good. So maybe just starting on the bioproduction business. Can you walk through what's embedded in your guidance for this year, now that we know the pieces of the business a little bit better and maybe kind of walk through exactly what you've incorporated in the guidance.

Certainly there. So on the guidance basis, we didn't change the guidance for the Bioscience Production segment. Just that continues to be mid-single-digit growth in guidance just for bioprocessing within it.

Okay.

And we took that from mid- to high-single digits to mid-single digits. The performance in single-use and process ingredients is exactly as we expected to the year it was the same in Q1 on that. The primary difference was -- primary difference was the headwinds in control environment consumables in Q1. We've made some modifications to some of our go-to-market there. We've seen improvements in the past few months. But just given the Q1 impact and not assuming a full recovery, that's what we took bioprocessing for mid to high to mid.

Okay. So that's 30% of your business saw a little bit of weakness in...

30% of the bioprocess.

Thank you sir, thank you for that. And so how should we think about that going forward ex this Q1 flip? Is that -- would the whole bioprocessing business? Is that a good way to -- the high mid-single-digit ex this onetime issue in Q1? Is that a good way to think about that business?

Absolutely feel strongly about the growth of those. We're -- the great part of our portfolio is it's driven by throughput, we're largely not subject to capital cycles or anything else there. It's throughput of drugs. In my other comments, the approvals the volumes of scripts, that business is functioning exactly as I wanted to do as this recovery cycle is coming in.

And what percentage exposure do you have to early stage early-stage biotech development versus late stage.

So all of the early-stage development exposures in the lab business, nothing in the bioproduction virtually nothing in the bioprocessing side.

Perfect. All right. So bioprocessing, mid-single-digit growth. Let's talk about the other 2 pieces because obviously, those are having a drag on the overall business. So can you walk through what you're assuming for growth rates for those? And how do those businesses compare on just -- are they cyclical, are there different macro exposures?

Yes. First, I wouldn't call them I wouldn't call them a drag on growth there. When you go through our silicones business, that's at least a mid-single-digit grower there. We talked about that and the expectations for the year. I mean we have exceptional technology with our competitive moat there and the customer relationships both on the medical side and the aerospace side. And then the other applications, we have had headwinds in electronic materials that will annualize kind of in Q2, Q3, but those should be mid-single-digit entitlements there. So you combine -- when you're getting the full throughput and you don't have the CEC headwinds, high single-digit bioprocess, these other pieces of the business that can be mid-single digit or a better can bring you to that mid- to high single-digit entitlement for the segment.

Got it. So obviously, too early to start talking about 2026. But as we exit this year, it sounds like that will be a better run rate for how you think that overall business will look because you've got kind of these onetime issues with -- on the bioprocess side will be gone and then any of the tough -- the comps will get easier on some of the other businesses. So if you've got mid- to high-single digits is a good way to think about that the entire business with x Lab Solutions going forward?

No, I think that's absolutely fair. I think -- but I think an important thing for the year, even with those headwinds, our guidance for the segment is mid-single digits. So you're seeing the bioprocess recovery, you're seeing execution in that business.

Right. Now I guess the next question I have is, again, with all of this clarity and the fact that you are going through the divestiture of one business. Should investors think of, hey, maybe these business -- some of these pieces aren't core? Would you consider divesting any of them? Is that -- are you trying to signal that as an option at all? Or is this purely just for clarity and that's not something that investors should really dig into?

Yes, I would say, short answer is, this is all about investor clarity. We had enough questions about that, that we felt that one's in important thing to do. Look, we're always looking at the portfolio. I mean that's what you do. Fundamentally, management is always successful what you have, and it's all about maximizing value, but there's no signaling to this that this disclosure is due to divestiture thinking.

Great. Thank you for all of that clarity. Maybe we'll move on to the start talking about the other 2/3 of the business, the Lab Solutions. So can you walk us through on that business as well, what's incorporated in your updated guidance? There were some moving pieces, including what you called competitive intensity. And obviously, some NIH impact. So maybe just walk through what you're thinking of that business for the year, and then we'll get into some of the pieces specifically.

Yes. So the original guidance for the business was both single-digit growth, and we modified that to minus low single digit to flat for the Lab Solutions segment. when we talked about Q1 and then the reasons for the updated guidance, the primary driver in Q1 was what we broadly call sort of the policy implications, i.e., the NIH funding piece of it. Now that primarily impacts U.S. higher education part of the business of total revenue at Avantor that represents about 5% of revenue. We saw meaningful impacts in Q1 in connection with that. So that's the primary driver of the adjustment to the guidance.

Okay. So let's dig in there a little bit. So this is -- 5% of your business, you're seeing a slowdown and that started kind of mid-February when there was -- I mean, I guess it's probably even a weak going into last year, but mid-February, we had these NIH proposals where there -- it looked like the NIH would cease funding for certain grants. Was that kind of -- is that the timing of when you saw a real slowdown and maybe walk through what's embedded for the rest of the year. And post that, have you seen any change in buying patterns from your customers that do receive NIH funding?

Sure. So first, when we provided guidance, and we made some comments about this, we knew there were some uncertainty in the environment. So we were careful in our guidance in that connection. The day we released Q4 and provided guidance that evening, the NIH news hit the tape. So that was a perfect timing in that connection.

That was the social media posts that they put out, right on ...

That's right. Yes. So we've seen just fine performance, even though some uncertainty at the beginning of the year, where you saw sort of immediate impact and then it's gotten back to a pace even though there is impact on the demand there, but that business has frankly been pretty consistent since that and very similar to how we guided for 2024. And that we're just assuming continuation of, again, solid performance, but with some of the dampening due to that for the balance of the year, and that's exactly within the guidance.

And so here we are late May, almost in June. And so have you seen any change in what those customers are doing? Was it -- and just by way of background for those in the room and on the phone that don't know what we're talking about. So February 15, there was a post where the NIH said we were going to stop funding a specific percent of grants that have already been approved, that we're already paying for. Anything related to indirect costs we're going to limit that to only 15% of the total grants, anything above that, we're no longer going to fund. That was blocked in the courts and that's an ongoing debate. But we did some checks and we put out some public -- we published notes on this, but basically, it created uncertainty for any academic institution that received NIH funding via grant. So that came out February 15, just so we're all clear. So that created an initial shock is my understanding from the customers. And so what has developed since then?

So a couple of things. There's -- there was a shock, but there's been consistency since then just at a somewhat lower level. And that's absolutely what informed our guidance there. I mean people are open for business just at somewhat of a lower level on that. Now when you have a shock like that, the reaction from people is predictable. They want to preserve cash, preserve resources. So the most immediate impact is on capital. So equipment and instrumentation impacted the most. Another important part of it, though, is we're really an activity and throughput-based business there. So when you have head count reductions when you have slower replacement of staff in that, you have less people working on things, so that also has had some impact on consumables and chemicals there. But again, it's just, it's the somewhat lower activity to your point, the shock in the system, habit quickly and then it has stabilized since then, just at a somewhat lower level.

But from a relative perspective, you are more on the consumables side than equipment. Do you sell any equipment into those...

We definitely do. So -- as a firm, capital is about 15% of our total revenue. In Lab, it's about 20%. And then in higher ed, it's a somewhat higher percentage. So it is an important piece of the business.

Okay. Got it. So it was more capital that's probably impacted this year, although...

Definitely.

Somewhat on the consumables Okay. And is that -- just going forward, first off, did you have any Lab customers at these universities that their labs shut down that are no longer purchasing. Have you seen that impact yet? And just longer term, how does this -- other than the initial shock, do you think this changes the health of that piece of the business within Lab Solutions.

So -- I mean, I don't know every lab or any of that, but certainly nothing of that has come to my attention. Look this comment we make frequently. It's the gold age of science, the -- even if this creates a baseline that you grow off in that. But frankly, the fact that we've seen the consistency in the business even at the other demand levels is encouraging given the level of uncertainty and I don't believe it resets what the business will be over time.

Great. And just outside of the U.S. policy, 1 other piece, which is it's a smaller piece of the guidance cut, but you highlighted something called competitive intensity. And I just want to talk about that a little bit. Is that something new that you're seeing? Or is that just something that you wanted to highlight that's outside of the NIH? And maybe if you could give any more color on that.

Sure. No, I think we just highlighted that as good disclosure. The -- when people ask questions about competitive intensity, I mean, it absolutely is a competitive business. That is nothing new. When you have circumstances where you're not getting the full volume growth you'd have otherwise, then people will compete for the buckets of growth that there are, and we'll compete for share that way. So we did see an increased level of that. And However, and definitely in some -- a handful of large accounts, there were volume shifts that impacted us. On the other hand, we had a number of really good wins in Q1. Those won't hit the P&L for a few quarters in that. But certainly, there is nothing in the statement to say, oh, we're impacted by the competitive intensity, but we're not driving competitive intensity ourselves, which we are -- and they'll tell you the new leadership in Lab, what Corey Walker is doing there, very impressive. So we're going on the offensive there in a good way.

Okay. And so the timing for that to reverse. I mean, it sounds like the new wins that you -- you've got, that will be a couple of quarters. So should we think about this will be -- it will take 2 to 3 quarters to drag out that this -- this headwind will continue and then will go away and potentially reverse and become a tailwind as some of those wins at the P&L?

Yes. Look, I'm a big believer in what that business wants to do. We need to get through the period of uncertainty, but I would say we're taking really significant actions there to drive the business.

Okay. Great. And then -- the other piece I wanted to touch on for guidance is tariffs. And maybe can you remind us what was incorporated in your guidance, specifically related to tariffs and then we'll move from there.

So we actually did not incorporate any tariff impact in our guidance and the foundation for that is because we believe we'd be able to offset it. Now it's obviously a very, very dynamic environment right now, but sort of the bottom line to put in the bullet point there is we don't expect to have tariff impacts into the P&L this year, particularly after the changes. So the gross exposure has decreased dramatically. We're now saying that the in P&L impact is the cost impact of tariff taxes would approximately be $30 million, which we believe we'll be able to offset. The vast majority of that is China to the U.S. and then the balance is from other regions. Unmitigated, that would be $0.03 to $0.04 of EPS. We already have significant plans in place there. Now it's a combination of alternative suppliers from regions where you don't have the same tariff impact, that's either tariff surcharges or price. We're working very closely with our customers on that. Obviously, no one wants those things to happen. And again, that's with the new leadership in Lab. I think we're executing very thoughtfully and we feel good about how we're going to mitigate that.

And obviously, the policy -- the tariff situation is fluid and it changes almost on a daily basis. But anything that you're seeing that potentially now with the new policy, hey, maybe this will be a tailwind, especially if you're able to put through some pricing? Or is it the impacts will only be done to mitigate the headwinds, and we shouldn't be thinking about any type of actual tailwind this year from...

I mean, mitigants in price can help the top line there, even though we didn't incorporate that into guidance. But No, I wouldn't take that as a tailwind to guidance.

Okay. Great. And just a high-level question. You did cut organic guide by 200 basis points, but you left EPS where it is. Is that I mean, you've got a range on the EPS? Or are there -- is that because you're finding more opportunity on the cost outs -- or are there other actions you're taking to offset the revenue headwinds you're seeing? How -- or should we think -- okay, now we should be looking more towards the lower end of the range on EPS or...

No. No. We certainly haven't directed to the lower end of the range there. I mean the simple math there is we guided the year with $1.03 euro dollar and it's -- and the update was $1.10 we ended at $1.10 for the year. So that's FX dropping through. So the 200 basis points in Lab is offset by the FX tailwind.

Right. Okay. Makes sense. And, we've only got a few minutes. So I did want to touch on the CEO transition. Can you give us any update on that process and kind of what you see as the ideal candidate to replace Michael?

Look, it's -- I wouldn't want to get ahead of the board there, but they're leading that process, and I believe they'll find the right person there, and they're moving expeditiously.

Okay. Got it. That's a good update. What challenges has this presented for you? Obviously, you came on board and you've done a lot. You changed a lot of the company, which I'll give you credit for just because you're here, but you changed the reporting structures of the business. You just gave more disclosures. You found a bunch of cost-outs that obviously helped the earnings power. Now you've got a -- assuming your burden -- you have a higher burden with departing CEO. So just how has your role shifted and kind of -- how do you think that will evolve over time.

Well, 2 pieces there. First off, I would never individually take credit for anything there. That is a team sport, and we have a great team. No, my burden hasn't changed here. Look, Michael made this decision with the Board. It was the right time for him. And frankly, he is the CEO and he's engaged as he's ever been and the other members of senior management are just as focused and it's frankly all about driving improvement in the business. That's all we're focused on.

Right A couple of high-level questions. So from a long-range target perspective, you guys did an Analyst Day at the end of '23, I believe. And so when should we see the next Analyst Day, if you've talked about that and kind of what types of things are you seeing now in markets versus what you saw at the end of '23? And how important has seeing in market stabilization for you before you lay out new long-range targets?

I mean we haven't scheduled one yet there, so we'll see on that. I don't -- our long-term view hasn't changed. Obviously, there's been an unprecedented amount of end-market is since the last Investor Day, and none of us had hoped for that. But the long-term view on both what this platform can do and what our entitlement is absolutely hasn't changed.

Great. Well, that just about wraps up our time. So Brent, we appreciate you attending the conference. We appreciate all the clarity you gave in the slides. And thank you for everyone here and everyone attending in home. We appreciate it. Thanks.

Thank you. Good to be here.