Avantor Q3 2023 Earnings Call Transcript

There are 13 speakers on the call.

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 Avansthor's Third Quarter 2023 Earnings Results Conference Call. After the prepared remarks, there will be the opportunity for any questions, which you can ask by pressing star followed by the number 1 on your telephone keypad. I will now turn the call over to Christina Jones, Vice President of Investor Relations.

Operator

Mrs. Jones, you may begin the conference.

Speaker 1

Good morning. Thank you for joining us. Our speakers today are Michael Stubblefield, President and Chief Executive conference call, and Brandon Jones, Executive Vice President and Chief Financial Officer. The press release and The company's call is 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.

Speaker 1

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. 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.

Speaker 1

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.

Speaker 2

Thank you, CJ, and good morning, everyone. I appreciate you joining us today. I'm starting on Slide 3. 3rd 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 3rd quarter were similar to the conditions in the 2nd 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.

Speaker 2

Sales of bioproduction materials for cell and gene therapies was another bright 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 $650,000,000 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.

Speaker 2

Baker MCA tips for the TECAM Fluid 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 Doctor. Jaribrophi, including experts in biologic manufacturing and technology, chemistry and gene therapy, who will guide our research and development efforts and leveraging our Avanfor business system to continue executing on our productivity initiatives. Looking ahead to the Q4, we are assuming that the demand trends we have experienced over the last couple of quarters continue.

Speaker 2

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 would 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 Q3 results in more detail.

Speaker 3

Thank you, Michael, and good morning, everyone. Before I take you through our Q3 results, I would like to share some early observations. I know our end markets well from my days at Pall Corporation, and I'm thrilled to be back in the space at a company like Avanthal 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 at what the team has been able to build at Avon Tor.

Speaker 3

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 Avanxor 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.

Speaker 3

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 3rd quarter numbers on Slide 4.

Speaker 3

Reported revenue was $1,720,000,000 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 finished 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.

Speaker 3

Finally, we saw another Strong quarter in higher education in the Americas, where we've seen a significant pickup over the last 6 months. Adjusted gross profit for the quarter was $579,000,000 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 blunt these effects with our productivity efforts, both on the plant floor and through targeted supply chain efficiencies. Adjusted EBITDA was approximately 318,000,000 Our Q3 adjusted EBITDA margin of 18.5% was in line with our expectations for the quarter.

Speaker 3

Year over year, our EBITDA margin performance was impacted by lower gross profit and negative fixed cost leverage on SG and 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 $193,000,000 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.

Speaker 3

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 $650,000,000 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 3rd quarter revenue performance. Core organic revenue declined 7.9% in quarter.

Speaker 3

COVID related revenues represented an approximately 1.7% headwind for the quarter, Reflecting the expected roll off of approximately $30,000,000 of COVID related sales from the Q3 last year. Net net, This results in a 9.6 percent organic revenue decline. Foreign exchange translation represented a 2.3% tailwind, driven by a modest depreciation of the euro, 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.

Speaker 3

Our increased commercial intensity in education and government is driving share gains and led to the 3rd consecutive quarter of growth With higher education growing high single digits in the quarter. In addition, biomaterial sales were 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. Aimia declined 5.4% on a core organic basis in the 3rd quarter, Driven by declines in lab consumables and single use solutions as well as formulated solutions for our semiconductor customers.

Speaker 3

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 Q2. This is negatively impacting activity levels in research labs and constraining capital purchases, Putting pressure on both consumables and equipment and instrumentation sales.

Speaker 3

Sales to midcap and largecappharma 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 and D pipelines and fund promising science. In the production environment, sales were similar to our 2nd 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.

Speaker 3

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 and the fundamental drivers for biopharma, including a robust pipeline of trials and approvals across mAbs, 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 3rd quarter, The 3rd consecutive quarter of growth, driven by high single digit higher education growth in the Americas.

Speaker 3

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 core organic basis in the 3rd quarter, driven by declines in the Americas and EMEA, largely attributable to inventory destocking at our semiconductor However, there are early signs that OEM inventory health is improving and we are beginning to see modest sequential improvements 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 products and formulated solutions for semiconductor customers, partially offset by strong biomaterials sales. Sales of 3rd 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 3rd consecutive quarter, While equipment and instrumentation declined high single digits reflecting constrained capital spending in the current macro environment.

Speaker 3

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.

Speaker 3

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.

Speaker 3

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 for 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.

Speaker 3

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 625,000,000 to $675,000,000 With that, I will turn the call back to Michael.

Speaker 2

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.

Speaker 2

There are currently more than 260 Phase 2 clinical trials in gene therapy underway. More cell and gene therapies are expected to be approved in 2023 than in the past 5 years combined. And the Nobel Prize winning research led by Katalin Carico And Drew Wiseman 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.

Speaker 2

Finally, I'll close with a reminder that we are hosting an Investor Day on December 8 at 9 am 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. Our first question today comes from the line of Dan Brennan with TD Cowen. Dan, please go ahead. Your line is now open.

Speaker 4

Great. Thank you. Congrats on the quarter. Brent, nice to meet you. Look forward to seeing you in person.

Speaker 4

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 You know, 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 Q4? And then importantly, as you look at like your order book and the stabilization, like how we might think about the outlook for 2024?

Speaker 2

Yes, 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 Seems to have caught the bottom here.

Speaker 2

Trends and order books have been stable over the last couple of quarters. 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 I think all the signals are all pointing in the right directions 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.

Speaker 2

And certainly, The pipelines continue to advance and I would say the end market there continues to be quite solid. So we are We 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 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 in a continuation of the trends that we've been As we think about 2024, it's a little bit early for us to call that.

Speaker 2

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 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 that's still my expectation. And when I think about that in the context of the broader space, I think you see the relevance in the positioning that we have here You're holding up well.

Speaker 4

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 appears to be ongoing There, Thermo talked about the end market being kind of negative right now in terms of the growth rate and they assume that continues at least for the 2024 base. You guys seem more optimistic. I'm just trying to think through, is this more of a mix basis?

Speaker 4

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 things 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.

Speaker 2

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 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 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.

Speaker 5

Hi, Michael. Good morning and thanks for taking my question. I just want to touch upon the Martins here, Michael. For Q4, I think there's sequential step down of 100 basis points for adjusted EBITDA margins. Looks like your revenues sequentially are stable.

Speaker 5

So is this the gross margin issue sequentially or Are you assuming an SG and A step up here in Q4? Maybe some thoughts on what's driving the Q4 margins would be helpful.

Speaker 2

Yes, 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 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 3rd quarter And that continues to be an important area of focus for us as we think about managing working capital in this environment.

Speaker 2

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. We've also taken a pretty close look at just our overall inventory health. There's a bit of inventory cleanup here as we work towards the end of the year. And then I would say maybe to a lesser extent, A third factor being a modest impact from some of the customer wins that I mentioned that are driving some of our above market growth The education space, I think those are probably the key factors. As I go below the GM line, there is some modest Step up in SG and A really particularly on a sequential basis as we think about maybe not some of the The transactional FX tailwinds we saw in Q3 repeating and some one time SG and A benefits that we saw in Q3 that we don't expect Repeat in Q4, but it's primarily all held up at the gross margin level, Vijay.

Speaker 5

That's helpful, Michael. And yes, I did notice your free cash performance certainly at the high end of the industry, so that's on free cash. Maybe one for Brent here on Brent, what's the right way to think about 2024? I'm not asking for guidance. It's more What is the right jump off point?

Speaker 5

Should I be looking at Q4 trends? And is that the jump off point? Or are there some one off Items here in Q4, because I think that implied us maybe 17.5 percent, sub 17.5 percent adjusted EBITDA margins. Is that the right jump off point we should be thinking of for next year?

Speaker 3

Yes. Juan, good to speak with you. I think following on Michael's comments, it's too early to get to the exact jump off for 2024. We are in the middle of our budget process. There are so many puts and takes there.

Speaker 3

So I I don't think it's the right time to make the call, but we will be talking to everyone again soon and we'll definitely go on a normal guidance No cadence, pardon me, and give you clarity in the months to fall.

Speaker 5

Understood. Thanks guys.

Operator

Our next question comes from Jack Meehan with Nephron Research. Jack, please go ahead. Your line is now open.

Speaker 6

Thank you. Good morning. Michael, wanted to ask about what you're seeing at large pharma and large biotech. You described it as stable. We have seen some headlines around budget cuts from some large players.

Speaker 6

I was just curious what you're seeing and what you're assuming Kind of for the Q4.

Speaker 2

Yes, good to hear your voice, Jack. Thanks for the question. I I think as you look at the results that we just printed and the reconfirmation of our guide For the Q4, we really are seeing the trends that we originally discussed maybe back in the second quarter persisting through the back half of the year and that's including the research environment within biopharma. The funding headwinds that we ran into earlier in the year on biotech It seemed to have bottomed out in the Q2. We saw relative stable revenue performance in that customer segment in the Q3 and we're assuming something similar for the Q4.

Speaker 2

Under the heading of, I would say positive signals and sentiment. I think if you look at funding for biotech, there is maybe some incremental bright spots In that space here over the last quarter or 2 to keep us optimistic about that space. But we've caught the bottom there and we're assuming stability here in the quarter. Large pharma mid to large pharma is an area where we also were starting to see some cautionary spending Trends creep into the business there as we emerge from the Q2. It played out largely in line with Expectations in the Q3 and we're assuming that those trends continue here in the Q4.

Speaker 2

I think when I step above funding and budgets and kind of the cautionary posture that we see in the market right now, we ultimately hang our hat Just a promising science that is being funded. The pipelines are incredibly robust. There's a number of Blockbusters moving their way through the pipeline activity level continues to be quite strong. And as I've referenced a couple of times, The commercial intensity that we're applying and have been applying over the last number of months really has us positioned well here. Our Activity levels with our customer as we think about heading into the year end here is as strong as it's been all year.

Speaker 2

So we continue to be Cautiously optimistic here as we close out the year.

Speaker 6

Great. And then I was wondering if you could share your thoughts on capital equipment instrumentation, just what your expectations are for the 4th quarter? And maybe more broadly, we're seeing a little bit of a used market emerge for equipment that was placed the last few years. I was curious if you're Seeing any examples of that and just what you think is going on? Thanks.

Speaker 2

So as you know, the capital Part of our business is relatively modest. It's less than 15% of our revenues and it tends to be focused on kind of the lower Dollar value purchases within our customers' budgets, I think less than $50,000 type equipment and instruments. And we've seen, I would say, relative stable performance on a dollar basis over the last couple of quarters. I think when we look at how we've reported the quarter, there's a modest step down on a percentage basis, but That's more driven off of just the year over year comps, but the revenue has been relatively consistent over the last couple of quarters. And we're Our expectation is that continues into the Q4.

Speaker 2

And of course, as we get into the Q4, it's not it's quite Topical or timely to talk about year end budget flushes and which is a dynamic that we would typically experience that Towards year end and it's primarily concentrated in this area of capital equipment as customers look With the way we've guided the back half of the year, we're not expecting a year end budget flush. And so as I think about the 4th quarter On a relative revenue rate or performance, we would anticipate capital equipment spending in Q4 to To be similar to what we saw in the Q3.

Speaker 6

Sounds good. Thank you.

Operator

Our next question comes from Michael Ryskin with Bank of America. Michael, please go ahead. Your line is now open.

Speaker 7

Great. Thanks for taking the question guys and great to work with you, Brent. Looking forward to it. First, I want to talk a little bit about sort of the curve improvement as it shows up going forward. I think This quarter you guys really talked about encouraging trends, sentiment improvements, just more positive Feedback, not so much orders improving or anything like that.

Speaker 7

But as we think through going into next year and beyond, how should we visualize that curve of the rebound? It's been more than 4 quarters of challenges in the market and for you in terms of declines and destocking some of these pressures. So once things do inflect back up, Is it going to take 4 quarters to get back to normal? Or is it going to move a little bit faster than that just because once it's washed out, it will come back quickly?

Speaker 2

Right. I certainly understand the question, Michael, and we're as anxious as you are and everyone else is You try to understand and get some clarity as to how the shape of this recovery is ultimately going to unfold. Unfortunately, when we think about The short order cycle of our business, particularly in the lab part of our business, which is measured in days weeks, We really don't have a crystal ball that tells us when these orders were ultimately going to turn around. And We end up then trying to triangulate just based on what customers are telling us about their expectations for next year, How the destocking trends are playing out and what's the health of their overall inventory. And as I look at the feedback that we've Aggregated here coming out of the Q3 and look at the sentiment and the expectations from our customers, particularly within biopharma, Overwhelmingly, they're anticipating next year to be a stronger year than 2023.

Speaker 2

Undoubtedly, inventory levels are Improving many customers reporting normal inventories at this stage And the percentage of customers that are holding outsized inventories has declined significantly. So The signals continue to be positive, but with a short order cycle business like we have, it is difficult for us to get really Specific, particularly where we sit here in October to call what the timing of a turnaround would be going into next year. So we'll take the benefit of the next couple of months and we'll be back to you on how we think about 2024 when we get into February.

Speaker 7

Okay. Fair enough. And then just kind of to follow-up on that, Michael, just to your point on the short order, the short cycle nature of the business and some of that limited visibility. There's been a lot of updates in biopharma in the last couple of months in terms of major cuts, reorgs. The Pfizer announcement a couple of weeks ago certainly was the most notable one, but not the only one.

Speaker 7

So can you sort of contrast that with your commentary on Improving tone and improving sentiment. I mean is that some of those cuts that we're seeing in pharma, is that something that you've already been experiencing for a couple of quarters, so it's not really incremental? Or why does that not correspond to what you're hearing from your customers now?

Speaker 2

I think that's the right way to think about it, Michael, is We've been calling those headwinds out now for a couple of quarters and have had that baked into our outlook in the second half. The fact that particularly those that had outsized COVID exposure are starting to curtail activities and reset their outlooks And adjust their activities accordingly is not incremental information for us. It's a trend that has Fueled this cautionary posture that we've seen from large pharma over the last couple of quarters. And with some of those resets now in place and I would say the reprioritization of pipelines and focus on things like cell and gene therapy, it really does favor our model where we're well positioned with a pretty compelling Spring into that space. So, yes, I think the way you're thinking about it is about right.

Speaker 2

These are not incremental to what we've already been experiencing the last couple of quarters.

Speaker 7

Thanks so much.

Operator

The next question comes from Patrick Donnelly with Citi. Patrick, please go ahead. Your line is now open.

Speaker 8

Hey, guys. Good morning. Thanks for taking the questions. Brent, maybe one for you on the good morning, Michael. Brent, maybe just on the margin side, Just trying to get a little more granularity in terms of the moving pieces for 4Q.

Speaker 8

Would you be able to quantify what feels more one time, so again, Particularly the inventory charges, is it fair to kind of ballpark that around the cash flow increase bridge like that $12,500,000 Maybe just try to flesh That out a little bit for us as we try to think about again kind of that core 4Q number maybe outside some of the one timers.

Speaker 9

Yes. I mean with

Speaker 3

Thinking about a one timers versus on a rate basis, absolutely for sure absorption is an issue you always have to Managed as Michael indicated there, I mean that will depend a lot on the going forward, but we're playing pretty tight attention to that. So I think that has a At least a one time nature as well as the inventory is definitely a one time nature. So on a rate basis, Probably at least half of it, I would put to one time and the rest of it is real based on the underlying activity.

Speaker 8

Okay. That's helpful. And then Michael, maybe a similar vein, just on the pricing outlook. You mentioned some of the Kind of contracts you got on the academic education side, but maybe just talk about overall pricing, what you're seeing in the business, how much Discounting you guys are doing versus seeing pricing increases and then similarly I guess in that bioprocessing market as that comes back How you think about the pricing environment as you work your way towards the recovery?

Speaker 2

So pricing for us has been relatively stable throughout the year. We did our customary increases early in the year, have been quite frankly pleased that we haven't had to go back to multiple times this year. And I know our customers have appreciated the relative stability we've been able to bring to them this year. And so it's been relatively quiet throughout the year from a pricing standpoint and we're getting the traditional Price over COGS contribution to our margins that we would have seen historically and that are underpinned our long term growth algorithm. So As I think ahead to the pricing environment, I would say it's constructive.

Speaker 2

And ultimately, as we think about the actions we'll take Next year going into next year, it's going to somewhat depend on where inflation starts to settle out. And we're right in that process now of getting The quotes and pricing terms with our suppliers, which is an Important input into how we think about then setting our customer pricing going into next year. But it's been, I would say constructive and stable and in line with our expectations.

Speaker 8

Understood. Thank you, guys.

Operator

The next question comes from Rachel Van Stahl with JPMorgan. Rachel, please go ahead. Your line is open. Perfect.

Speaker 10

Thank you for taking the questions. So I want to ask on health Cara, just given the high single digit declines were stepped down from the mid single digit growth in 2Q. So you'd flagged some bio material strength, but that was more than set by the consumables weakness in the Americas and Europe. So can you just walk us through some more color on why there was that sequential step down? And then are you expecting healthcare to return to growth into 4Q and beyond.

Speaker 2

Yes. Thanks for the question, Rachel. Pretty perceptive actually. The healthcare Platform for us, which is about 10% of our overall revenues, has a couple of critical components. 1, a little more than half of the revenues are going to be In the content that we provide to our diagnostic customers and then the other third or 40% would be in our The Biomaterials platform, which as you called out has been a real source of strength for us throughout 2023.

Speaker 2

We delivered yet another quarter of strong double digit growth and We continue to be excited about the innovation and the positioning of our technology offering in that space and anticipate that that momentum Certainly continues. The issue on a within the Q3 was not really on a relative Revenue basis, it actually printed right in line with how we would have incorporated into our guidance. We are running into a year over year comparable issue. If you look back into the Q3 of last year, I think we called it out at the time, particularly through our Ritter business, There was some pretty meaningful revenues that we had anticipated to come into Q4 that made it in under the Shifting deadlines for Q3. So we had a little bit of an outsized performance in our Ritter platform, which is reported in this Healthcare segment In the Q3 of last year, that was really more timing as opposed to underlying demand.

Speaker 2

So that's probably the biggest factor Driving the reported percentages there, Rachel, in the quarter. And we would anticipate 4th quarter On a percentage basis returning to a more normal print for us. But just to be clear, That platform for us played out the segment and the end market played out for us as we would have anticipated.

Speaker 10

That's helpful. Thanks. And then I wanted to follow-up on Dan's question just to push on 2024 a little bit more. So as Dan mentioned, one of your peers earlier this week noted that they're Expecting market growth in 2024. So your previous long term core growth organic guide was roughly in 1%, so given those comments from your peer pointing towards market declined.

Speaker 10

Is it reasonable to assume that top line will decline for you guys next year on a core basis? Or given that minimal China exposure, having less COVID headwinds, Is it possible for you to grow top line next year?

Speaker 2

Yes. So firstly, I'm not sure it's especially productive for me to try to unpack comments that one of my peers Has made and would caution just to try to take the comparison and the definition of how each of us look at the market. Our portfolios, as you suggest, are vastly different. Our end market exposures are vastly different as is our geographic exposure is vastly different. So It's probably hard for us to try to reconcile how others might be trying to call market growth for next year.

Speaker 2

But what I can say for our portfolio And mix. Certainly, limited China exposure is a good thing right now. We are bullish on the region long term And we'll continue to make and seed growth investments, particularly in the biologics space. But not having China exposure today is obviously A good thing and will be a tailwind for us as we move into 2024. Having a consumables driven portfolio, I think is So a real positive and strength for our platform.

Speaker 2

We've certainly been plagued by destocking and the inventory headwinds over the last Number of quarters, but we do see that coming to the end. And the underlying demand in our end markets It's stronger than what we've been realizing given that inventory drawdown. And then the last thing I would just reiterate The sentiment is improving. I like our positioning. Certainly, I like the funnel of activities that our teams have We've been able to build and we're anxious to see the order books turn, which will then give us a little bit more clarity on the shape of 2024, but probably a bit early for us to try to call that or give any more clarity than that from where we sit.

Operator

Our next question comes from Luke Sergott with Barclays. Luke, please go ahead. Your line is now

Speaker 11

open. Great. Thanks. Good morning, Brent. Welcome aboard.

Speaker 11

I promise it's not usually this bad in this space. You certainly joined during an interesting time. So I guess I just wanted to follow-up here on the 4Q margin. If we kind of back out the inventory and your commentary on that, Is it safe to assume that it's closer to you guys would have put up closer to about 18% EBITDA margin run rate? And is that safe for us to use From a modeling perspective on a jump off?

Speaker 3

Again, it's I mean, I think you're triangulating to something that make In terms of taking the one time out, we really aren't making a call on 24 right now. So I Michael has made those comments I think very astutely on it. Again, we'll give more color going forward there. And you could you can say, oh, you're just avoiding 24 on me. But the reality is there are so many puts and takes on it.

Speaker 3

Your volumes, absorption, all the rest of it, the growth in other businesses. So it's a complicated look and Just one quarter of the exit of a challenging environment. I don't want to start your thinking for 2024 kind of off the cuff.

Speaker 11

Yes, perfect. Thanks. And then lastly here, how are you guys thinking about or can you just Talk a little bit about the conversations you're having with biopharma customers. I assume that you still don't assume a budget flush. And is that really the conversations you're having, is there a chance that that's getting pushed out?

Speaker 11

Or is pharma starting to Talk to you guys more about things starting to come online next year. Give us a sense of it's kind of like another way to ask Riskin's question on kind of the curve, but if pharma is showing a lot more interest, you're starting to see a lot faster After decision making, we can get a little bit more positive on that recovery portion.

Speaker 2

Yes. A couple of comments to address your Question, when I think about budget flush, as I mentioned earlier, we haven't contemplated that in our guidance and certainly that would be Upside to our current plan if it were to occur, but we don't really anticipate it. And for us, This topic of budget flush really is concentrated to our equipment and instrument category, which is less than 15% of our Revenues, so not the primary driver of our business. But as we talk to our customers about Activity levels and such and clearly from a consumables perspective, as I mentioned before, the underlying demand for our products is higher than what we've been printing in our last couple of quarter results or actually over the last year or more, just given the inventory draw that we've seen at our customers. And as that is starting to normalize and we talk to our customers about specific their Expectations for next year for activity level, I think the sentiment is just given The pipelines that they're working on, the areas of focus that they have, the anticipation is that activity levels will be higher next year.

Speaker 2

And as These inventories are normalized. We'll not only benefit from a higher level of activity, but certainly we'll also be able to capture the underlying demand that's been satisfied here Over the last year or 2 with inventory. So our customers continue to be quite encouraged, I would say, by what they're working on. And the end market demands and themes continue to be quite strong. And I like our positioning.

Speaker 2

I like The amount of activity, the commercial intensity we've applied to keep ourselves relevant in front of our customers, our innovation engines are hitting on all cylinders And giving us the right products to solve our customers' challenges. So I couldn't be more excited about our positioning. And I think we're doing all the right things to control costs and the other things that are within our control here that will only strengthen us as these end markets will ultimately turn.

Speaker 11

Great. Thank you.

Operator

The next question comes from Dan Leonard with UBS. Please go ahead, Dan. Your line is now open.

Speaker 9

Thank you for the time. Michael, I have a question on cell and gene therapy. Can you help me reconcile your commentary there with the market trends? That market's been hit especially hard by biotech funding constraints. Other suppliers have recently lowered their long range plans in the past 2 months and you sound very bullish.

Speaker 9

So I'd love to learn more about your thinking.

Speaker 2

Yes. So when I talked about the Optimism around cell and gene therapy and the impact that it had on our Q3 results, really talking about the commercialized platforms that are in the market results. That are being produced today. There is, I would say, incremental traction in that area. There's been a number of approvals this year.

Speaker 2

And given our offering and the work that we've seeded over the last number of years, we are incredibly well positioned, Notwithstanding some of the manufacturing challenges and inefficiencies associated with launching these new modalities, We continue to be very well positioned there with an extremely relevant offering and the specifications that we As we've run our model here and collaborated with our customers, Is resulting in strong double digit growth of that platform. When I look at the pipeline, Which is driving our R and D activities, the pipeline has never been stronger either. Are there customers that are optimizing and Our program is falling out certainly as is usual as programs progress through that funnel. But as I indicated in my prepared remarks, The number of promising programs there that are advanced to Stage 2 and working their way through the pipeline here, The curve is accelerating meaningfully and we have a relevant offering and this is going to be important growth driver for us over the long term. Mabs from a revenue standpoint is still driving the bulk of our revenues, but it is nice to be able to already start to see the next waves of growth and where they're ultimately going to come from for our industry And certainly cell and gene therapy and particularly gene therapy is going to be one of those areas for us.

Speaker 9

That's helpful color. And a follow-up on bioproduction more broadly. Are you seeing any differential trends across your offering in that space, whether it be formulation products versus single use versus pumps. And is there any forward insight to be gleaned from those trends, whether one is more reflective of end customer demand versus another? Yes.

Speaker 2

I think we're seeing similar trends across Our offering there, you're right to touch on our process ingredients and excipients and chromatography resins and such. And We're seeing headwinds in those categories, not really related to inventory because we don't think there's been a stocking issue on those categories, but more just related to our customers managing their end product revenues and resulting in just Campaign push outs and delays and maybe cutting batches in their campaign schedules. And then on the single use side, not only do you see the activity headwinds that are hitting our Processed Ingredients business, But you also then have the double whammy there with the inventory stocking that we've talked about that does continue to be improving. So I wouldn't call out anything specific in terms of differences between the different components of our portfolio. But under the again, under the heading of anecdotally good evidence, good sentiment The engineering activity that front runs our single use order book continues to be quite strong.

Speaker 2

And when I look into forecasts and things we're getting from our customers for 2024 overall, This is a space that's growing. Some of my team has been in talking in the region in Asia here recently. And if you look at some of The growth that some of those customers are reporting, it's impressive. We just finished another great quarter in Asia on bioprocessing, excluding China, which is modest In any event, so there are a number of bright spots in this space that give us reason to believe that brighter days are ahead here.

Speaker 9

Appreciate all that color. Thank you.

Operator

Our next question comes from Catherine Schulte with Baird. Please go ahead, Catherine. Your line is now open.

Speaker 12

Hey, guys. Thanks for the questions. Michael, you mentioned that the percentage of customers that are holding out those inventories has declined significantly. Can you just give some numbers around where that is today based on your surveys or conversations with customers and how that metric has trended throughout the year?

Speaker 2

Happy to do so. When we first started to look at inventory health and trying to really get insights, let's try to help us triangulate just the trends. There were a number of customers, both in the lab With our lab consumables as well as in bioprocessing, particularly in single use that reporting excess of years' worth of inventory. It wasn't everyone, but Certainly a meaningful number of customers that were signaling they had more than a year's worth of inventory. Certainly our Ritter platform has Suffered under that pressure of excess inventory as an example.

Speaker 2

And as I look at the work that we've done on both The lab side of our business as well as bioprocessing, we have no customers that are reporting those levels of inventory. So it's all come in under A year and I would say the overwhelming majority of our customers find themselves in that we're right where we want to be or less than 3 months of excess inventory that's in their stock. So I would say just The absence of customers that are sitting on more than a year of inventory is a real bright spot for us. And the fact that Almost all of the customers are now signaling less than 3 months, if not already where they want to be, is another Data point fueling our optimism for our recovery here in the coming quarters.

Speaker 12

Great. And then if you go back to the prior question, if you look at the delta between excipients and other products going into biologics and then single use where you've seen more inventory destocking. Has that performance spread narrowed at all? How the items that didn't see stocking performed and what does that tell you in terms of underlying activity levels?

Speaker 2

So that was one of the surprises I think that we talked a little bit about in the second quarter was Kind of a turn down in some of the excipients and process ingredients, which really linked Our customers starting to more aggressively manage their end product revenues and not really linked to Stocking of our products. And we've seen that continue in the Q3 and our anticipation is that continues in the Q4 as well. And that's certainly how we've guided the quarter. So I wouldn't say that the spread has changed as we've moved through the Q3 or into the Q4. I think we're the way we've called this here as you see us reaffirming our revenue guide has things relatively stable at the moment.

Operator

Those are all the questions we have time for today. So I'll turn the call back over to Michael for any closing remarks.

Speaker 2

Yes. Thank you all for participating in our call today. Certainly look Forward to updating you at our Investor Day on December 8th. Hope many of you can join us at that event. And until then, be well, everyone.

Operator

Thank you everyone for joining us today. This concludes our call and you may now disconnect your lines.

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Earnings Conference Call
Avantor Q3 2023
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