Avantor, Inc. (NYSE:AVTR) Q3 2023 Earnings Call Transcript

Avantor, Inc. (NYSE:AVTR) Q3 2023 Earnings Call Transcript October 27, 2023

Avantor, Inc. misses on earnings expectations. Reported EPS is $0.1598 EPS, expectations were $0.25.

Operator: Good morning. My name is Emily, and I’ll be your conference operator today. At this time, I would like to welcome everyone to Avantor’s Third Quarter 2023 Earnings Results Conference Call. [Operator Instructions] I will now turn the call over to Christina Jones, Vice President of Investor Relations. Mrs. Jones, you may begin the conference.

Christina Jones: Good morning. Thank you for joining us. Our speakers today are Michael Stubblefield, President and Chief Executive Officer; and Brent Jones, Executive Vice President and Chief Financial Officer. The press release and a presentation accompanying this call are available on our Investor Relations website at ir.avantorsciences.com. A replay of this webcast will also be made available on our website after the call. Following our prepared remarks, we will open the line for questions. During this call, we will be making some forward-looking statements within the meaning of the Federal securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings.

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Actual results might differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of the date that they are made. We do not assume any obligation to update these forward-looking statements as a result of new information, future events or other developments. This call will include a discussion of non-GAAP measures. A reconciliation of these non-GAAP measures can be found in the press release and in the supplemental disclosure package on our Investor Relations website. With that, I will now turn the call over to Michael.

Michael Stubblefield: Thank you, CJ, and good morning, everyone. I appreciate you joining us today. I’m starting on Slide 3. Third quarter business results were in line with our guidance across all key financial metrics, including core organic revenue contraction of 7.9% and adjusted EPS of $0.25. As anticipated, market conditions in the third quarter were similar to the conditions in the second quarter, as inventory destocking and cautious customer spending continued to impact demand in our Biopharma, Healthcare and Advanced Technology and Applied Materials end markets. These headwinds were partially offset by continued strong growth in sales to our higher education customers and in our biomaterials platform, where we delivered another quarter of double-digit growth.

Sales of bioproduction materials for cell and gene therapies was another right spot in the quarter, reflecting our relevance in this growing space. Despite the industry-wide headwinds impacting the current environment, we are encouraged by the relative stability we have seen over the past couple of quarters and remain focused on executing the actions that we outlined in July to accelerate our growth strategy and control costs. This quarter, we continued those actions, including strengthening our balance sheet by paying down more than $650 million of debt year-to-date as free cash flow conversion in the quarter exceeded 110%. Winning several new customer contracts and renewals in Biopharma, Education and Healthcare, as a result of our strong competitive position and enhanced commercial intensity.

Continuing to add innovative proprietary products to the portfolio with our Avantor magnetic mixing system for single-use mixing needs and J.T. Baker MCA tips for the Tecan Fluent Handling platform. In addition, we generated strong momentum with Oxford Nanopore, one of our strategic suppliers for cell and gene therapies. Launching our Scientific Advisory Board led by Dr. Ger Brophy, including experts in biologic manufacturing and technology, chemistry and gene therapy, who will guide our research and development efforts and leveraging our Avantor Business System to continue executing on our productivity initiatives. Looking ahead to the fourth quarter, we are assuming that the demand trends we have experienced over the last couple of quarters continue.

Although, activity levels remain strong and overall inventory health is improving, we have not yet seen a change in order patterns. Nevertheless, customer sentiment does seem to be improving, and we remain bullish on our outlook for the mid to long term, given the strength of our platform and overall market positioning. Before I turn the call over to Brent, I remind you that he joined us in early August as part of our previously announced CFO transition. In the relatively short time that he has been with us, he has onboarded quickly and has already proven to be an excellent partner to me and to our leadership team as we work together to advance our growth strategy. With that, let me turn it over to Brent to walk you through our third quarter results in more detail.

Brent Jones: Thank you, Michael. Good morning, everyone. Before I take you through our third quarter results, I would like to some early observations. I know our end markets well from my days at [indiscernible] Corporation, and I’m thrilled to be back in the space, a company like Avantor that is so well positioned to benefit from the long-term secular growth opportunity that these markets offer. That said, my excitement is about much more than the end markets. I’m very impressed what the team has been able to build at Avantor. We have an incredibly strong foundation and the right core capabilities and talent to drive the growth and margin capture you have come to expect. I also believe that Avantor is unique within our space, the combination of our world-class channel and leading proprietary consumables portfolio is compelling.

These make our revenue base both highly recurring and resilient and we’ve shown the ability to convert strongly to cash, no matter the weather. Finally, our capital intensity is relatively low. To me, this is a proven recipe to generate significant shareholder value. We do have work to do on business insights, capital allocation and business optimization. Part of what attracted me to Avantor is the opportunity to build on our strong foundation and leverage my operational experience to accelerate growth and performance. I’m excited for what is ahead and look forward to helping lead us through the next chapter. Now moving into the third quarter numbers on Slide 4. Reported revenue was $1.72 billion for the quarter, while revenue declined 7.9% on a core organic basis, it was essentially flat on a sequential as reported basis, consistent with what we told you in July.

The organic background has remained relatively static. We are navigating an environment with ongoing destocking and demand weakness in Biopharma, as well as continued softness in the Advanced Technologies and Applied Materials end markets. We were encouraged to see modest incremental sales improvement at the end of the quarter from our semiconductor customers suggesting that our OEM customers finish goods inventory levels are beginning to recover. We also had another strong quarter in Biomaterials, which was up double-digits and provides a nice mix tailwind to offset headwinds in our other high margin businesses. Finally, we saw another strong quarter in Higher Education in the Americas, where we’ve seen a significant pickup over the last six months.

Adjusted gross profit for the quarter was $579 million and our gross profit margin was 33.6% in line with last quarter on an absolute and rate basis. Year-over-year, our gross profit was impacted by lower sales volume, mix, inflation and negative fixed cost leverage. However, we were able to partially block these effects with our productivity efforts both on the Plant 4 and through targeted supply chain efficiencies. Adjusted EBITDA was approximately $318 million. Our Q3 adjusted EBITDA margin of 18.5% was in line with our expectations for the quarter. Year-over-year, our EBITDA margin performance was impacted by lower gross profit and negative fixed cost leverage on SG&A. We are working aggressively to offset these headwinds with productivity initiatives.

Interest and tax expenses were in line with our expectations. As a result, adjusted earnings per share came in at $0.25 for the quarter, reflecting the flow-through of adjusted EBITDA performance. Moving to cash flow. We generated $193 million in free cash flow, reflecting more than 110% conversion of adjusted net income in the quarter and approximately 95% on a year-to-date basis. Our Q3 performance was enhanced by continued disciplined working capital management. Our adjusted net leverage ended the quarter at 3.9 times adjusted EBITDA and we have paid down over $650 million of debt this year, which represents a 10% reduction in total debt. Deleveraging remains our top capital allocation priority, and we continue to target an adjusted net leverage ratio below 3 times.

Slide 5 outlines the components of our third quarter revenue performance. Core organic revenue declined 7.9% in the quarter. COVID-related revenues represented an approximately 1.7% headwind for the quarter, reflecting the expected roll-off of approximately $30 million of COVID-related sales from the third quarter last year. Net-net this resulted in a 9.6% organic revenue decline. Foreign exchange translation represented a 2.3% tailwind, driven by a modest appreciation of the EUR resulting in a reported revenue decline of 7.3% for the quarter. On to Slide 6. From a regional perspective, the Americas declined 7.9% on a core organic basis largely consistent with Q2 as we continue to experience pressure in the Biopharma and Advanced Technologies and Applied Materials end markets.

Our increased commercial intensity in Education and Government is driving share gains and led to the third consecutive quarter of growth with higher education growing high-single digits in the quarter. In addition, biomaterial sales up double-digits, driven by strong demand for our custom formulated silicone solutions in medical implants and healthcare applications. Europe declined 8.6% on a core organic basis in the quarter, consistent with our expectations. On a year-over-year basis, Europe’s performance was again driven by weakness in the Biopharma and Healthcare end markets, with softer demand for lab consumables and single-use solutions driven by ongoing destocking. AMEA declined 5.4% on a core organic basis in the third quarter, driven by declines in lab consumables and single use solutions as well as formulated solutions for our semiconductor customers.

Despite the macroeconomic challenges, particularly in China, our business saw solid growth in bioproduction process ingredients, services and biomaterials. Slide 7 shows our core organic revenue change for the quarter by end market and product group. Biopharma representing almost 55% of our annual revenue, declined high-single digits with similar performance in both research and production. In the research environment, we saw a continuation of the conservative approach to customer spending that we witnessed in the second quarter. This is negatively impacting activity levels at research labs and constraining capital purchases, putting pressure on both consumables and equipment and instrumentation sales. Sales to mid-cap and large-cap pharma customers appear to have stabilized relative to last quarter and the sales rate to our biotech customer base has been relatively consistent since the beginning of the year.

While spending is constrained, customers continue to advance meaningful R&D pipelines and fund promising science. In the production environment, sales were similar to our second quarter results as demand continues to be impacted by inventory destocking and customer campaign delays. However, the environment does seem to be stabilizing and we continue to see encouraging signals from our customers. Anecdotally, inventory health continues to improve and single-use engineering drawing activity remains strong. Our focus on cell and gene therapy is paying dividends, yielding double-digit growth in several critical product lines targeting these workflows. We are confident that these signals will translate into improved order book trends and sales in the coming quarters and continue to have high conviction in the fundamental driver Biopharma including a robust pipeline of trials and approvals across mAbs (ph), cell and gene therapy and other modalities.

Healthcare, which represents approximately 10% of our annual revenue, declined high-single digits on a core organic basis. Consumable sales declines in Europe and the Americas were partially offset by continued strength in biomaterials where sales of our high purity formulated silicones were up double-digits in the quarter. Education and Government, representing approximately 10% of our annual revenue grew low-single digits on a core organic basis in the third quarter, the third consecutive quarter of growth, driven by high-single digit higher education growth in the Americas. We are encouraged by our recent commercial wins and the supportive funding environment and expect continued momentum in this platform. Advanced Technologies and Applied Materials, representing approximately 25% of our annual revenue declined low double-digits on a core organic basis in the third quarter, driven by declines in the Americas and AMEA, largely attributable to inventory destocking at our semiconductor customers.

However, there are early signs that OEM inventory health is improving, and we are beginning to see modest sequential improvement in the outlook for this business. By product group, Proprietary Materials and Consumables offerings were down low double-digits in the quarter with destocking and reduced demand for bioproduction and formulated solutions for semiconductor customers partially offset by strong biomaterial sales. Sales of third-party materials and consumables declined high-single digits, impacted by continued destocking of lab consumables and reduced demand across research settings. Services and specialty procurement, which integrate us directly in our customers’ critical operations grew mid-single digits for the third consecutive quarter, while equipment and instrumentation declined high-single digits, reflecting constrained capital spending in the current macro environment.

Slide 8 provides an update on our full year guidance. As Michael noted in his overview comments, the backdrop for Q4 is relatively consistent. So in terms of our full year outlook, we’re maintaining our revenue guidance but tightening our range around the midpoint, adjusting our margin expectations and raising the midpoint of our free cash flow guidance. To get into specifics, we expect full year core organic revenue growth of negative 6% to negative 5% and organic revenue growth of negative 8.5% to negative 7.5%. In each case, this tightens our range but retains the same midpoint. After accounting for a 50 basis point tailwind from FX, we anticipate full year 2023 reported growth of negative 8% to negative 7%. This tightened guidance reflects the themes we’ve discussed so far this morning.

We continue to perform solidly against the end market backdrop and things appear to have stabilized, evidenced by our sequential performance and expectations, but have not yet shown significant signs of improvement. Our long-term bullishness remains intact and is well supported by the markets we serve, but the near term remains challenged from a growth perspective. While top line is behaving as expected, we are facing some margin headwinds. We now expect adjusted EBITDA margins of approximately 18.5% to 18.8%, lowering our midpoint by about 50 basis points. This is due to incremental pressure from manufacturing absorption, inventory charges and modest mix impact from growth in the lower-margin education end market. Interest expense and tax expectations are unchanged from our Q2 update, so the resulting flow-through to adjusted EPS results in a revised range of $1.02 to $1.06 with the midpoint at the bottom end of our previous guide.

We expect our strong free cash flow performance to continue. The working capital management you saw in Q3 will continue to drive strong conversion to cash. As a result, we are raising the midpoint of our free cash flow guidance, free cash flow for the full year is anticipated to be $625 million to $675 million. With that, I will turn the call back to Michael.

Michael Stubblefield: Thank you, Brent. It’s great to have you here. Without question, we are operating in a dynamic environment. We are responding by driving initiatives to accelerate growth, enhance productivity and control costs, which together will put us in an even stronger position when the end markets turn. We’re also in the midst of the Golden Age of scientific discovery, driven by rapid innovation and the promise of new biologic therapies that have the potential to change lives. There are currently more than 260 Phase II clinical trials in gene therapy underway. More cell and gene therapies are expected to be approved in 2023 than in the past five years combined and the Nobel Prize winning research led by Katalin Kariko and Drew Weissman has opened up a whole new field of synthetic biology.

I know I speak for our leadership team, ensuring that we have both a deep sense of responsibility and pride for the role we play in helping set science in motion. I’d like to thank our associates for their commitment to our mission and for their focus on commercial and operational execution. Finally, I’ll close with a reminder that we are hosting an Investor Day on December 8 at 9:00 a.m. at the New York Stock Exchange. We look forward to seeing many of you in person or on the webcast. I will now turn it over to the operator to begin the question-and-answer portion of our call.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Dan Brennan with TD Cowen. Dan, please go ahead. Your line is now open.

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Q&A Session

Daniel Brennan: Great. Thank you. Congrats on the quarter. Brent, nice to meet you. Look forward to seeing you in person. Maybe first one, Michael, just — maybe we can just start with bioprocess. Obviously, it’s a big part of your business, and you guys have talked pretty favorably on this call about stabilization and activity. Could you just give us a sense of like the underlying growth rate this quarter, kind of what you’re assuming in the fourth quarter? And then importantly, as you look at like your order book and the stabilization, like how we might think about the outlook for ’24?

Michael Stubblefield: Yeah. Good to hear from you, Dan. I hope you’re doing well and thanks for the question. Bioprocessing is an important part of our business, as we’ve talked before, it’s roughly 25% of our business or thereabouts. And I think we are encouraged that we seem to have cut the bottom here, trends and order books have been stable over the last couple of quarters. And we continue to be encouraged by some of the momentum we see particularly in things like cell and gene therapy, where we had another really good quarter. I would say customer sentiment continues to be strong. The work that we do to understand inventory trends and production trends and such. I think all the signals are all pointing in the right direction and certainly, the health of our customers’ inventory is definitely improving.

We talked last quarter a lot about some of the leading indicators for our single-use business, things like engineering drawings and I continue to be encouraged by the strong level of activity that we see in that part of the business as well. And certainly, the pipelines continue to advance, and I would say the end market there continues to be quite solid. So we are — continue to be bullish about the mid to long-term prospects for that business. We’re anxious to see order books turned as we indicated in the call, in our prepared remarks, we’ve not yet seen that happen, and we’re certainly keeping a close eye on that and I would anticipate that, that would happen in the coming quarters. But the business is playing out about as we had anticipated with relative stability over the last couple of quarters.

And as we think about the quarter ahead in Q4, I think the way we’ve guided it is more of the same and a continuation of the trends that we’ve been seeing. As we think about 2024, it’s a little bit early for us to call that. We’re right in the middle of our annual planning process, and we’ll take advantage of the next couple of months to put that plan together and we’ll be prepared to give our formal 2024 guidance when we get into our Q4 call in February. But as I think about bioprocessing as it relates to 2023, we’ve talked about our core organic growth rate being off mid to high-single digits for the year and speaking of — that’s my expectation. And when I think about that in the context of the broader space, I think you see the relevance and the positioning that we have here holding up well.

Daniel Brennan: Great. Thank you. And then maybe just as a follow-up, your smaller China exposure and instrument orientation obviously is a nice benefit given the volatility that is — appears to be ongoing there. Thermo talked about the end market being kind of negative right now in terms of the growth rate, and I assume that continues, at least for the ’24 base. You guys seem more optimistic. I’m just trying to think through, is this more of a mix basis? Is it more execution? Maybe just broadly, as you define like your end market and kind of how it’s doing, like if we’re thinking about as we turn the page into 2024, even though you’re not guiding, is the right outlook to think like we’re stable in the first half improvement? Just any color on that kind of addressable market and the broader demand trends you’re seeing? Thank you.

Michael Stubblefield: Thanks, Dan. I don’t think we have any particular insights that would enable us to call when we see the end markets turning. We are encouraged by the relative stability that we’ve seen in market and customer sentiment does seem to be improving. So I don’t want to get ahead of our process here yet on 2024. But I think we are encouraged by what we are seeing. I would also say that the actions that we’re taking are within our control, the doubling down on commercial intensity to accelerate growth and the cost actions that we’re taking — are taking hold. Our teams are working incredibly hard to get our teams in front of our customers. We’ve made some significant investments in our digital capabilities that are enabling more personalized marketing and campaigning at scale that we’re getting some nice traction on.

And so when I think about just where we’re at in the backdrop and where we’ve come from, the investments that we’ve made in growth and the actions we’re taking to control costs certainly will have us positioned to emerge from the current environment stronger when the end markets do ultimately turn.

Operator: Our next question comes from the line of Vijay Kumar with Evercore ISI. Vijay, please go ahead. Your line is now open.

Vijay Kumar: Hi, Michael. Good morning and thanks for taking my question. I did want to touch on the margins — margins here, Michael. For Q4, I think there’s a sequential step down of 100 basis points for adjusted EBITDA margins. It looks like your revenues sequentially are stable. So is this the gross margin issue sequentially or are you assuming an SG&A step-up here in Q4? Maybe some thoughts on that. What’s driving the Q4 margins would be helpful?

Michael Stubblefield: Yeah. Happy to give you some color on that, Vijay, and thanks for the question. You are right. And as we signaled, we are signaling a bit of incremental margin pressure as we work through the balance of the year here and have adjusted our full year outlook by about 50 basis points or so. It is mostly a gross margin dynamic relative to — related to a couple of key themes here, Vijay. Firstly, hopefully, you noticed the strong free cash flow performance that we generated in the third quarter. And that continues to be an important area of focus for us as we think about managing working capital in this environment. And so part of what we’re reflecting here in our margins is, again, strong focus on managing our own working capital and inventory levels and throttling back production levels incrementally which is resulting in a bit more under absorption than what we had originally planned.