Michael Stubblefield: Good morning, Luke. Thanks for the questions. Starting with Masterflex. As Tom mentioned in his remarks, we continue to be incredibly optimistic about that business, not only from a growth standpoint, but also margin standpoint. It’s one of the leading franchises in the single-use space and gives us one of the only end-to-end aseptic fluid management solutions in the industry. Really great traction, strong brand recognition, and we’re thrilled to have it as part of the portfolio. The inventory destocking that we talked about related to particularly the tubing offering associated with that, continues to play out as expected. It might have been a little bit stronger in Q4 than maybe what we had anticipated, but not far off of that.
We expect to see that to be through the first half of the year, as I mentioned. I imagine as we work through the first quarter and sort of transition to the second quarter, we would anticipate things to start to incrementally improve and would anticipate having that behind us, as we move into the second half of the year. The other headwind that we faced in Masterflex is just the ongoing chip and component shortages for – peristaltic pumping technology. We’ve got a great order book there and a backlog that continues to build. So I think we certainly draw confidence from the strong demand and positioning of that technology. And the supply chain continues to improve. We do still have certain components that we’re struggling to get on time, but we’re starting to see incremental improvements there.
And as Tom mentioned, I think as we get to the second half of the year, we’re expecting double-digit core organic growth for that business. Really appreciate your second question as well. We continue to have really great traction and momentum with our customers. This is an important part of our business model, the unparalleled customer access that we do enjoy. And when I look at 2022, the team did just a remarkable job in renewing and extending relationships with new customers, as well as acquiring new business. We referenced in the fourth quarter a pretty significant agreement that we were fortunate to put in place with Catalent, where we became their primary supplier of a broad range of laboratory supplies and clinical and production materials and end services that will significantly expand our current relationship with them.
We also extended the duration of our lab supplies and lab services relationship with Janssen Pharmaceutical Companies of Johnson & Johnson and that came with a pretty significant upfront investment. But we’re really excited by the positioning we have with that business and the duration that we were able to achieve with that extension. So just another good example of the traction we have and momentum we have in the business. Tom mentioned in his comments around free cash flow that some of these relationships do require a bit of an upfront investment that we were able to reflect in our cash flows in Q4, which will give us significant returns as we enjoy the revenues of those relationships as we move forward. Thanks for the question.
Operator: The next question today comes from Vijay Kumar of Evercore ISI. Vijay, please go ahead.
Vijay Kumar: Hey, guys. Thanks for taking my question and I had a two-part, Michael, maybe I’ll start with you. The guidance here, when I look at the midpoint core organic, 3.5 for the year, that’s 150 basis points below your LRP. And when I look at Q1, I think that number is 750 basis points. So one, is all of this inventory destocking you know, macro industrial slowdown? Is that happening in Q1? Is that the bridge between your 5 to 3.5 for the annual, and I thought, for some reason, Q4, those headwinds were around 300 basis points. So why is it accelerating here in Q1? And one for Tom on – on margins here, Tom, I thought you said pricing was positive. Can you clarify what the pricing assumption is for fiscal ’23 and why shouldn’t pricing aid your margins here in ’23?
Michael Stubblefield: Yes. Good morning, Vijay. Thanks for the questions. I’ll take the first one. The midpoint of our 2023 core organic guide of 3.5% contemplates roughly 250 basis points of macro impact, and that would include certainly the impact of destocking. It would include our view on kind of just the general macro environment and the impacts on our applied markets, perhaps most notably in the semiconductor market, as we mentioned in the prepared remarks. And so that gets on that basis to the high end of our long-term guide of roughly 6%. So very much in line with what we’ve been doing over the last several years. As you think about then the phasing within 2023, I think the headwinds that we’ve talked about are certainly most pronounced in Q1.
We’ll have a – destocking effects in Q1 are certainly most pronounced there, as well as just our view of the macro impacts on some of our applied markets. I’d also note in Q1, kind of relative to where we’re at in Q4. Q1 is one of our most difficult comps of the year. I think we’re running into a comp that’s probably 300 basis points plus in Q1 compared to where we were at in Q4. So it’s certainly going to be a situation here where the second half will be stronger than the first half, as we work through some of these destocking events.
Thomas Szlosek: And Vijay, on the second question. Thanks for the question on the margins and in particular, on pricing. Just to reiterate what’s behind our guidance. I think it’s helpful to remind ourselves, since the IPO, we’ve been tracking to the high end of our margin expansion long range plan of 50 to 100 basis points, nearly at 100 basis points or so when you each of those years. So the drivers are not much different than they’ve been in the past. And we like to think of it, as Michael said earlier, it has three components. The first being, the pricing and overall, what we call commercial excellence and in other words, balancing pricing against inflationary pressures on COGS inputs and other inputs. I think the – this has really proven to be a core capability of Avantor.
We’ve got fairly sophisticated approach, a lot of data, really strong talent and systems and software to drive us a little long in the process for 2023. It’s a big annual exercise starts in early November and really culminates right around now and working with suppliers and customers. So we’re well along. We have a high degree of confidence in our ability to drive the price to offset inflationary pressures and be accretive to margins, as Michael had said. So that’s definitely a positive factor for us. When you’re considering the range that we’ve given I certainly think the COVID headwinds need to be taken into account when you see roughly $200 million of revenue coming out of the plan from ’22 actuals to ’23. That’s pretty margin-rich content.
And since it’s mostly in biopharma production, vaccines and other kinds of content that go into — bio production vaccines. We’re reflecting that in the guide as well. And then I think overall, the third aspect in addition to mix is just productivity for margins. And we have plans in place, as we always do, that address material productivity, that address performance of our factories, performance of our distribution centers. And we’ll continue to be pretty vigilant on costs and know that will contribute to some potential movement to the higher end of the guide. So I wouldn’t look at our guide as reflecting anything materially different than what we talked about in Q3 and Q4 in our various meetings. I think we’re setting up in a way that I think as we look ahead, we feel that it’s pretty prudent start for the year in terms of expansion margin.
Operator: Your next question comes from Michael Ryskin with Bank of America. Please go ahead, Michael.
Michael Ryskin: Great. Thanks for taking the question, guys. I got a couple of parts, but it’s just one question. And I kind of wanted to touch on debt levels, interest expense and M&A. So could you just walk us through again the interest expense coming in higher year-over-year if the deleveraging remains a top priority. We thought it would kind of come down a little bit despite where rates ended at the end of the year? And then on 3Q, along those lines, previously on 3Q, you said we’re concentrating near-term M&A efforts on improving performance of recent acquisitions – and yes, using available free cash to reduce debt. Today, I think you had a comment about actively building a pipeline of M&A opportunities. So definitely noticing a tone change there.
Could you talk us through what’s going on? And is that something you’re referring towards the end of the year? Is there a certain leverage target you want to hit before you’re back to being in a hunt for more M&A? Just clarify the difference there.
Thomas Szlosek: Yes. Thanks, Mike. And I’ll answer the first question, and I’ll let Michael answer the second. In terms of our leverage and debt levels, things are playing out as we kind of articulated in our planning. We started out the year north of 4 times leverage in 2022. We ended at 3.7 times. And when you look at the impacts on interest expense and so forth, they’re also playing out as we expected. So we expect to continue on that delevering path. We’ll probably be – when we execute our plan in ’23, we expect to be in the low 3s, if not at 3, and we’re encouraged by momentum. When you look at the key drivers of the delevering for us, it certainly is free cash flow. And while 2022 didn’t exactly hit the mark on free cash, we were pretty pleased with how the interest itself was managed.
We had articulated at the beginning of the year roughly $260 million of interest expense. We came in roughly 266. And that’s with over 400 basis points of increases in various reference rates that impact our weighted average borrowing cost. So when you look at how we manage that, we did a few things to basically convert variable rate debt to fixed. We also, right before all the interest rate increases had taken place, we had a good portion of basically refinancing our entire portfolio. So over the course of 2021, we had significantly lowered our overall weighted average cost of borrowing. And the combination of those two things, that is the repricing, as well as some of the things we did in ’22 on swapping variable to – sorry, fixed to variable and the euro swap that we did.
We ended up improving the mix of our variable versus fixed rate where about 30% of our debt is variable rate, most of that is exposed to the euro. And as we look to 2023 interest expense, you’ve got two components there. Certainly, that 30% of the debt that’s variable. We do have some impacts, as I talked about and quantified in the past, certainly close to $50 million or $60 million of pressure on interest expense from that. But the delevering impact largely offsets most of that. And so if we deliver at the midpoint of our guidance range at 700 to 800 in free cash flow, I think we’ll be in pretty good shape. So we’re – we’ve called that interest expense roughly 270 to 290 million in the guide. So it’s relative to 266 in ’22 and considering the interest rate environment, pretty pleased with how that looks to come in.
And the more cash we can generate, the better we’ll do on interest expense.
