Avantor, Inc. Q2 FY2023 Earnings Call

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 2023 Second Quarter Earnings Results Conference call. After the prepared remarks, there will be the opportunity for any questions. I will now turn the call over to Christina Jones, Vice President of Investor Relations.

Good morning. Thank you for joining us. Our speakers today are Michael Stubblefield, President and Chief Executive Officer; and Tom Szlosek, Executive Vice President and Chief Financial Officer. The press release and a presentation accompanying this call are available on our Investor Relations website. 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. 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 supplemental disclosures package on our IR website. With that, I will now turn the call over to Michael.

Thank you, CJ, and good morning, everyone. I appreciate you joining us today. I'm starting on Slide 3. Our second quarter core organic revenue declined 6.5%. Relative to the first quarter, market trends weakened sequentially, particularly in biopharma, where mid to large pharma customers moderated their spending and continued to reduce inventory, and ongoing funding constraints for small biotech persisted. Sales in our Advanced Technology and Applied Materials end market were impacted by sharp declines in sales of formulated solutions to semiconductor customers. We also experienced sequential weakness in sales of equipment and instrumentation associated with tighter capital budgets across all end markets. The sustained momentum in our biomaterials and education end markets partially offset these declines, and we are encouraged by the double-digit growth in our medical-grade silicone platform, as well as continued mid-single-digit growth in education and government. We continue to leverage the Avantor Business System to drive cost savings and enhance operational rigor and efficiency. These productivity efforts and cost containment measures helped mitigate the soft demand environment and enabled us to deliver solid bottom line results, including a 19.7% adjusted EBITDA margin and $0.28 of adjusted EPS. We also have strong free cash flow momentum and generated approximately 85% free cash flow conversion to adjusted net income in the first half and paid down over $400 million of debt in the same period. While current market conditions are negatively impacting the entire industry, we are confident in our platform market position, long-term growth outlook, and the resilience of our end markets. We are doubling down on our actions to accelerate our growth strategy and control costs to help offset industry headwinds and ensure that we are positioned to capitalize when market conditions improve. First, we have taken steps to align our organization and key leadership roles to deliver incremental growth. We have added leaders with expertise in high-growth segments and welcome new leaders with a proven track record in driving performance. A few examples include strengthening business leadership for our proprietary research and materials businesses under Randy Stone, including adding dedicated leadership for our self-manufactured chemicals business, and augmenting Ritter leadership to drive revenue synergies and product line expansion. Establishing dedicated strategy leaders under Kitty Sahin's leadership who partner with business leaders to identify and capture high-growth opportunities. Adding product management leadership for bioprocessing, fluid handling, and lab digital services and realigning our regional commercial teams to enable greater focus on customer needs. These efforts are generating results. In the second quarter, in addition to delivering double-digit education and government growth in the Americas, our strength in commercial teams extended multiyear contracts with several renowned institutions and consortiums in the education sector, including the E&I consortium, which services over 5000 educational institutions and gives us broad access to the academic community. Second, we are accelerating new product introductions for both third-party and proprietary offerings and investing in Avantor's R&D to support customer needs. For example, in the second quarter, we launched integrated pressure sensors for our Masterflex MasterSense pumps, novel volume sampling systems to support cell and gene therapy workflows, and cryogenic storage vials to support the long-term storage of critical biological samples, and introduced a new robotics tip line, the J.T.Baker HT2. We significantly accelerated new product introductions from our supplier partners during the first two quarters, including onboarding several innovative suppliers to bring thousands of new fine chemical and antibody offerings to our customers, as well as introducing new microplate instrumentation and biological sample storage solutions. Additionally, we announced plans for a significant expansion of our flagship R&D center in Bridgewater, New Jersey, planned for August 2024. Third, we are well underway with our digital transformation, including enhancing our e-commerce platform and improving campaign execution and commercial activation processes. We will begin introducing our new online buying experience through a phased rollout across geographic markets starting this autumn. At the same time, we are simplifying and streamlining lab inventory and replenishment processes for our customers by integrating leading electronic lab notebooks and smart shelf platforms with our upgraded inventory manager enterprise system. We've increased web traffic through a variety of digital tactics, accelerated the deployment of new product and allocation-focused email campaigns, and enhanced some of our trigger or action-based campaign programs. We are seeing higher campaign conversion rates as a result of these initiatives. Additionally, we've activated commercial process enhancements that are improving effectiveness in our lead-to-order conversion rates. These tactics complement ongoing content upgrades and search engine optimization enhancements across our digital channels. We've also intensified our focus on operational excellence and productivity to control costs, as was evident in our second quarter results. Some examples of these efforts include rationalizing our manufacturing footprint through closures and downsizing, streamlining our organizational structure, and delayering, including simplifying our European organization from three sub-regions to two in order to reduce cost and complexity and better serve customers. Proactively addressing structural costs and reducing discretionary and indirect spend across our global organization, executing numerous Kaizen events as part of our Avantor Business System to expedite process improvements and drive stakeholder engagement and enhancing our supply chain to drive efficiencies, reduce back orders and improve lead times, including increasing warehouse productivity and efficiency as well as automation upgrades at our distribution centers in Germany, Sweden, the United Kingdom, and the US. Looking ahead, we are revising our full year 2023 guidance to reflect the more challenging environment the industry faced in the second quarter, which we expect to persist for the remainder of the year. We're also taking the opportunity to further accelerate our deleveraging and are now targeting adjusted net leverage below three times. I will walk you through our updated guidance at the end of the presentation. Before I turn it over to Tom to walk you through our second quarter financial results in more detail, I want to remind you of our previously announced CFO transition. As we announced earlier this month, Brent Jones will join Avantor as Executive Vice President and Chief Financial Officer on Monday, August 7th. Over a nearly 30-year career, Brent served as CFO for several public and private life science companies and previously as a senior investment banker. He is currently Executive Vice President, Chief Financial Officer and Chief Operating Officer at LifeScan Global Corporation, a global leader in blood glucose monitoring and digital health technology. Brent is an innovative thinker and seasoned operator with a strong track record of driving transformation, building teams and enhancing financial results to increase value for shareholders. He will be an exceptional partner in running the business, and I look forward to working closely with him to advance our growth strategy. As planned, Tom will be leaving Avantor next Friday, August 4th, to start a new CFO role outside the life sciences industry. As we welcome Brent to the team, I want to reiterate my appreciation to Tom for his many contributions to Avantor and his support of a seamless transition. With that, let me turn it over to Tom to walk you through our second quarter results.

Thank you, Michael, and good morning, everyone. Starting from the top of Slide 5. Reported revenue was $1.74 billion for the quarter. Revenue declined 6.5% on a core organic basis, reflecting high single-digit declines in biopharma and Advanced Technologies and Applied Materials, resulting from lower activity levels constrained spend, and continued inventory destocking by our customers, partially offset by ongoing growth in our healthcare, education, and government end markets. Adjusted gross profit for the quarter was 33.8%, with the reduction from 2022 driven by lower overall volumes, negative mix impact of lower bioprocessing and semiconductor revenue, and the roll-off of margin-rich COVID-19 revenues, partially offset by productivity efforts and lower distribution costs. Adjusted EBITDA was approximately $343 million. Q2 adjusted EBITDA margin of 19.7% was above our guidance, with positive impact from cost containment, productivity, and lower incentive compensation costs, offsetting the negative impact of lower gross profit margins. Adjusted earnings per share came in at $0.28 for the quarter, reflecting the flow-through of adjusted EBITDA performance, and interest expense in line with expectations, and a modestly higher tax rate. We also recorded a non-cash impairment expense of approximately $160 million in the second quarter, which reflects a reduction in the fair value of the Ritter assets driven by persistently high customer inventory in the end market served by Ritter and an overall slowdown in the research spending environment. The declines in actual and projected income for Ritter have also led to a reduction in current and future tax benefits, leading to a tax rate of 24.2% for the quarter. We remain focused on realizing the long-term growth potential of this business by introducing new products and leveraging our channel to expand Ritter's customer base. Moving to cash flow. We generated $138.1 million in free cash flow in the quarter, which enabled an approximately 85% conversion of adjusted net income in the first half of 2023. This year-over-year improvement in conversion has been primarily driven by sustained improvements in accounts receivable and inventory. Our adjusted net leverage ended the quarter at 3.9 times adjusted EBITDA, slightly higher than the first quarter as a result of lower trailing four-quarter adjusted EBITDA, partially offset by ongoing debt paydown. As Michael mentioned, we have paid down over $400 million of debt year-to-date, and deleveraging is our primary capital allocation priority. Additionally, we strengthened our balance sheet by upsizing our revolver capacity in the quarter from $515 million to $975 million and extended the maturity to 2028. Slide 6 outlines the components of our second quarter revenue growth. Core organic revenue declined 6.5% in the quarter. COVID-related revenues represented a 2.6% headwind for the quarter, reflecting the expected roll-off of approximately $50 million of COVID-related sales from the second quarter last year, resulting in a 9.1% organic revenue decline. Foreign exchange translation represented a 0.4% tailwind, driven by a modest appreciation of the euro, resulting in a second quarter reported revenue decline of 8.7%. On to Slide 7. From a regional perspective, the Americas declined 8.8% on a core organic basis reflecting weaker customer demand in biopharma and Advanced Technologies and Applied Materials. Biopharma results were pressured by sequential declines in both research and bioproduction, and semiconductor-related sales were down more than 80% as customers continue to reduce finished goods inventory as supply chains normalize post the COVID-19 pandemic. Education and government grew double-digits with robust funding and focused commercial execution supporting ongoing momentum and recovery in this end market. Biomaterials sales were also up double digits driven by strong demand for our custom formulated silicon solutions in medical implant procedures and healthcare applications. Our continued investments to debottleneck existing manufacturing assets paired with operational excellence initiatives are providing additional capacity to meet strong underlying demand in targeted markets and applications. Europe declined 1.8% on a core organic basis in the quarter, driven by weakness in biopharma and education and government end markets. We experienced softer demand for lab consumables and chemicals reflecting a weaker demand environment and ongoing destocking. The macroeconomic contraction over the past two quarters in the Eurozone, including the recession in Germany, also put pressure on Equipment and Instrument sales, which were down high single-digits in the quarter compared to high single-digit growth in the first quarter. Biomaterials grew double digits in Europe and Advanced Technologies and Applied Materials end market continued to grow, demonstrating the benefit of our diversified customer exposure and our increased emphasis on new high-growth segments. EMEA declined 8.7% on a core organic basis in the second quarter, driven by declines in formulated solutions for our semiconductor customers, which were down about 70% in the region and sluggish demand in research settings across all end markets, partially offset by strong core organic revenue growth in bioproduction. Slide 8 shows our core organic revenue growth for the quarter by end market and product group. Biopharma, representing almost 55% of our annual revenue, declined high single digits in both research and production. In the research environment, we saw an increasingly conservative approach to customer spending, resulting in project delays, site closures, reductions in headcount, and more aggressive procurement savings targets. This is negatively impacting activity levels in research labs and constraining capital purchases, putting pressure on both consumables and equipment and instrumentation sales. We are seeing signs of stabilization in the biotech customer base, which remained at Q1 sales levels in the second quarter, while sales to mid-cap and large-cap pharma declined in the quarter. While spending is still constrained, customers are continuing to fund promising science and advance a robust pipeline of clinical research and new molecules. In the production environment, our sales were down high single digits on a core organic basis compared to our expectation of low single-digit growth as realized in the first quarter. While destocking persisted as anticipated, we also experienced a sequential reduction in demand driven by improved lead times and campaign and project delays. Despite these challenges, we are seeing some encouraging signals. Customer survey data regarding inventory health continues to improve. We've also seen a marked uptick in engineering drawing activity, a critical leading indicator within our single-use platform. Our focus on cell and gene therapy is also paying dividends, yielding double-digit growth in several critical product lines targeting these workflows. We continue to have high conviction in the fundamental drivers for Biopharma. We are in an exciting time for science, and the pace of innovative research and regulatory approvals, including Alzheimer's monoclonal antibodies, GLP-1 treatments, and cell and gene therapies supports long-term double-digit growth in this industry. Healthcare, which represents approximately 10% of our annual revenue, grew mid-single digits on a core organic basis in the second quarter. Biomaterials performance was up over 30% in the quarter, with double-digit growth across all three regions driven by continued strength in surgical procedures. Education and government, representing approximately 10% of our annual revenue, grew mid-single digits on a core organic basis in the second quarter driven by double-digit 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 high single digits on a core organic basis in the second quarter, with solid performance in Europe offset by declines in the Americas and EMEA, largely attributable to softer demand from semiconductor customers. Semiconductor sales were down over 75% in the quarter, reflecting persistent high levels of finished goods inventory at our largest customers, and represent a roughly 220-basis point headwind to our core organic growth in the quarter. By product group, proprietary materials and consumables offerings were down 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 third-party materials and consumables declined mid-single digits impacted by continued destocking of lab consumables and reduced demand across the research setting. Services and specialty procurement, which integrate us directly into our customers' critical operations, grew mid-single digits, while equipment and instrumentation declined mid-single digits reflecting a more cautious approach to capital spending in the current macro environment. With that, I will now hand the call back to Michael.

Thanks, Tom. Turning to Slide 9, I'd like to take a moment to walk you through our updated 2023 guidance. As you recall, our prior guidance was predicated on a continuation of first-quarter end market dynamics and a modest seasonality pickup in the second half of the year. Given the sequential deterioration experienced in the second quarter, we are updating our guidance to reflect the second quarter revenue miss, and the extension of current end market trends through the balance of the year. This results in organic revenue declines of 9% to 7% and core organic revenue declines of 6.5% to 4.5%. Applying current exchange rates, we estimate reported revenue of $6.89 billion to $7.04 billion. We expect adjusted EBITDA margin to contract by between 200 basis points and 150 basis points, which incorporates our view of lower volume, offset by productivity and discretionary cost control. We expect interest expense of approximately $290 million and a full year tax rate of 23%, leading to adjusted EPS of $1.04 to $1.12. We're also updating our free cash flow range to $600 million to $675 million to reflect the adjusted EBITDA guidance and a continuation of our free cash flow performance from the first half of the year. Regarding phasing, we expect a relatively consistent performance between Q3 and Q4 for total reported revenue, adjusted EBITDA margin, and adjusted EPS. The primarily short-cycle nature of our business model, coupled with a dynamic operating environment, makes forward visibility particularly challenging. We believe our updated guidance appropriately reflects the realities of the current macro environment and does not contemplate any material change in end market conditions. We recognize that our second quarter results fell short and that we have made a meaningful change to our full year guidance to reflect the current market conditions. We remain confident in the long-term fundamentals of our attractive end markets and Avantor's proven platform, market position, and targeted growth strategy. We are taking aggressive measures to drive future growth, control costs, and improve productivity to ensure that our organization is well positioned to capture future market opportunities and emerge stronger from the current headwinds facing our industry. We are steadfast in our commitment to our mission of setting science in motion and to our customers, including investing in customer-driven innovation opportunities around the world. Equally important to helping customers solve scientific challenges is operating sustainably. In the second quarter, we committed to updating our emission reduction goals in line with climate science that will be validated by the science-based targets initiative. As a reminder, in 2020, we set a short-term target of a 15% reduction in greenhouse gas emissions by 2025, and we are on track to beat this timeline. We recently earned a bronze medal for our sustainability rating with EcoVadis. This improved rating is a significant validation of our commitment to sustainability. I would like to close by thanking our associates for their contributions to our customers and communities, as well as their focus on operational discipline as we navigate these dynamic times. I will now turn it over to the operator to begin the question-and-answer portion of our call.

Thank you. We will now begin the question-and-answer session. Our first question today comes from the line of Tejas Savant with Morgan Stanley. Please go ahead. Your line is now open.

Good morning, Michael, and thanks for the time here. Perhaps to kick things off, can you just help us allocate that 600 basis point haircut your core growth expectation across end markets and comment on linearity during the quarter and how July shaped up? And also, what exactly are you assuming in terms of a year-end budget flush in the new guide?

Hi. Good morning, Tejas, and thanks for the question. Happy to give you some color on how we have framed our full year outlook. As you suggest, we've dropped at the midpoint our outlook by about 600 basis points. If you unpack that, about 100 basis points of that is just a reflection of the Q2 miss getting rolled in. That leaves you with roughly 500 basis points, which is probably the way I'd think about it, roughly split in equal parts between our expectations for bioproduction as we move through the back half of the year as well as a continuation of the current rate of sales into our Biopharma research environment. I think that gets you to the 600 basis points that you referenced. If you think about the phasing of that, as I suggested in my prepared remarks, we anticipate Q3 and Q4 having roughly equal levels of reported EBITDA, EPS, as well as reported revenue. As we're working our way through July, I would just say the experience we're having up until now is consistent with how we're framing the outlook for the balance of the year. You had one more question, let me address that as well. If we think about the full year, what we've tried to do here is just recognize the current macro environment, the trends that we saw in Q2 and extend those through the balance of the year. That would really not contemplate much if any of a budget flush this year.

Got it. That's helpful. And then on share loss, Michael, any color there? I know in the past you've shared metrics like churn, web traffic, etc., all looking good. But just as you looked at those trends evolve, are you still confident that you're sort of outgrowing your end markets here? And any updated color on how you're doing relative to the customer R&D spend that you track?

Yes. Thanks for the question on the opportunity to weigh in. Yes, I think as you would expect, we continue to be rather bullish about our positioning within the end markets that we're serving. One proof point I would point you to this quarter is a validation of that is the strong growth that we delivered in the academic end market within the Americas. We grew in that space double-digits this quarter, which really is a reflection of the commercial intensity that we're driving across all of our end markets. As end market health is recovering in certain pockets, we're certainly there to grab our share or in this case probably more than our share of the available opportunities. We track a lot of different metrics. We hold ourselves to a high standard here and do expect to grow in line if not faster than our end markets. Whether it is our digital traffic, win rates, or share of our customers' R&D spend, these things that we do look at real time and we continue to be very confident that we're well positioned in each of the end markets that we serve.

Got it. Thanks for the time, Michael.

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

Great. Thanks for taking my question, guys. First, I kind of want to go back and do a little bit more comparison of your commentary after the 1Q call and in May at some of the conferences. And then today I think previously you kind of indicated that the majority of what you're seeing from Biopharma was destocking and any underlying demand, robust underlying churn. You highlighted, except the ends, some of the specialty chemical that was a couple of months ago. Now it seems like you're having a little bit more color on demand weakening. I was wondering if you could just elaborate on that. You mentioned R&D a little bit. Anything you can delineate between R&D and production, maybe you could give us a magnitude for the demand weakening from an end market perspective, how much has it slowed over the course of the quarter.

Thanks for the question, Michael. First, around destocking, I think from our perspective, the headwinds we face both in lab consumables as well as in our single-use solutions, we saw those destocking headwinds play out as anticipated. Consistent with previous reporting periods, we have done a tremendous amount of engagement with our customers, and the data we are getting from our customers certainly supports significant improvement in inventory health, which gives us some encouragement going forward. Relative to what we saw as we move through the quarter, in addition to the destocking playing out as anticipated, we did see market slowdown in overall demand in the production environment, as our customers adopted a bit more cautionary approach as we moved through the quarter. Part of that is certainly linked to managing their own working capital and their end market or their own end product inventories; part of that reflects our improvement in lead times. But we also see campaigns and projects getting pushed into the latter parts of the year and into next year. On the R&D side, similar dynamics in that as we move through the quarter, we started to see constrained spending of the capital budgets reflected in our equipment and instrumentation category, which I highlighted at a number of the public remarks we made in the quarter. We also saw a more constrained approach to spending across consumables and other categories as they implement their own productivity actions around site closures and headcount reductions. We certainly saw an impact on overall activity level in the quarter, which was a little bit of a change from what we've seen in previous quarters. It is encouraging, though, as Tom mentioned in his remarks, we did see stabilization within the biotech space, which was off significantly in Q1, and we saw it stabilizing in Q2. So those are a few of the things that we saw in the quarter.

Any way to just put a number on that, let's say, that end market used to grow 5%; has it gone down to 3%? Is it 0%? Is it negative 5%? Just give us some sense of how much demand has slowed.

Well, in both research and production, Michael, we were down high single digits in the quarter. If you kind of compare it with where we have been for Bioproduction, for example, in Q1 we grew low single digits. So, that was roughly a 10-point deceleration that we saw there in the quarter. On the lab side of things, we also saw that deteriorate maybe 5, 6, or 7 points in the quarter as well. So both parts of our Biopharma exposure certainly weakened as we moved into the second quarter.

Got it. That's helpful. Regarding the margin guidance, I appreciate your insights on the factors involved. However, based on my calculations, it seems you are projecting about a 100 basis points sequential decline in margins. You're estimating an EBITDA margin of approximately 18.7% to 18.8% in the second half compared to 19.7% in the second quarter, which indicates a 100 basis points drop in revenues that are relatively stable in dollar terms. Can you elaborate on what's causing this? Is it a shift away from proprietary products, reduced pricing, or are there additional costs expected in the second half? Please explain the margin changes for the second half.

Yes, there are two or three things there that I think are critical to understand. We're reflecting the step down in margins in the second half of the year as you referenced. If you look at what we said a quarter ago to what we're saying now, it's about a 125-basis point decline on a full-year basis. I would think about it as roughly 200 basis points associated with lower volumes and a weakening mix to reflect the experience that we had in the second quarter. That is offset by roughly 75 basis points of productivity and cost controls.

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

Great. Thanks for the question. Just a couple of clarifications here, Michael and Tom. Can you give us the update on the actual destock dollar in 2Q and now what you guys are expecting for the second half? Because you guys saw it before everybody else, so we would thought that you would see it alleviate before everybody else. So just give us an update on that, please?

Yes. Good morning, Luke. Good to hear from you. As we have talked about in previous quarters, we've been seeing somewhere in the order of 500 basis points to 600 basis points of destocking in our business. I think that's consistent with our experience in the second quarter. We have a new variable, a new dynamic though that is making the ability to give a precise number for destocking a little bit more challenging as we move into the second half of the year because we're also starting to see, or we did see, a deceleration in just overall demand within the bioproduction space linked to, again, a more cautionary approach and a push out of some of the projects and campaigns. It is difficult to parse that between demand versus destocking since it's pretty widespread at this stage. But I would point you to the data that we have on our customers' overall inventory health. This is something that we've been really close to for nearly a year now, and what we're seeing there is continued improvement. The survey data and the feedback from our customers continues to trend in the right direction. I think when I look at where our customers' inventory is of these destocked categories or these overstock categories and how they're thinking about forward demand, it is encouraging. When I look at the bioproduction category that was most overstocked, it was in our single-use platform. I referenced in my commentary one of the leading indicators that we look at in that particular business is overall engineering drawing activity. That's really the start of a customer's demand and kicks off the whole process. We have seen a market uptick in engineering activity as we got into the second quarter, and that will take time to convert into orders, and then there's a lead time on the back of that to get into revenue. But that is another signal that gives us some encouragement as we think about our current environment.

All right. Great. I have two quick follow-ups. When you mention engineering drawing, I work extensively with Excel, so I'm not familiar with what that means. Can you explain the timeline for when we can expect the engineers to start drafting plans? Which drugs are they focusing on, and when will they begin placing orders and manufacturing those drugs? Additionally, you mentioned that the inventory surveys are looking better. Have you incorporated any of this into your guidance, or could it potentially provide an upside in the latter half of the year?

Great question, Luke. On the engineering activity, as we talked before in our single-use platform, it's a custom platform where we're designing custom assemblies and manifolds and connectors. Every opportunity that we have with our customers is going to be unique and requires custom engineering. So they'll come to us with a request for a design. Our engineers will go to work and turn around a design. We'll collaborate with them, and ultimately that will translate into an order. That whole process can take a few months from when that is kicked off until it ultimately manifests itself in an order that they're ready to move forward with. Depending on what it was, we have lead times that could be in the two to three-month timeframe for building those products. I hope that gives you some color to what that would look like on a leading indicator basis. In terms of what we've built in here in terms of some of these positive signals, I'll just take you back to what we've said about how we've guided. We're grounded in the conditions that we experienced in the second quarter, and we've extended those through the back half of the year. So to the extent that there was a material improvement or, I guess, a material deterioration in either direction, that wouldn't be contemplated in our current numbers.

Great. Thank you.

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

Hi, everyone. Michael and Tom, good morning. I appreciate you taking my question. I have a quick question about revenues. What were the figures from China for the quarter? You mentioned that the guidance for the second half is based on trends from the second quarter. I'm interested in knowing if, in July, things were still reflecting the second quarter when considering the timing. Looking at the July exit rate, are we seeing an improvement compared to June, or are we at the same levels as in June?

Hey, good morning, Vijay. Thanks for the questions. On China, I've been clear that we don't have a significant exposure there. It's a few percent of our overall revenues. I would say that the trends that we saw in the second quarter are consistent with what you've heard others report: it is weak and not particularly constructive at the moment. That gets reflected then in the overall performance that we delivered in the EMEA region. When I look at kind of China being a source of weakness, I combine that with the semiconductor headwinds that we have in the region as well. Those are the key drivers for the print that you see there for the EMEA region. It does really unfortunately mask some pretty positive signals in our Bioproduction business in Korea and in Southeast Asia where we continue to see pretty strong core organic revenue growth. Regarding the experience in July, you are correct that we did see kind of sequential weakness as we moved through the second quarter. I think our experience in July does reflect what we were seeing there toward the end of the quarter and is certainly contemplated in our view that it's prudent at this stage to extend those second quarter trends through the back half of the year.

That's helpful, Michael. And Tom, all the best to you as you transition, maybe one on the margin question for you here. Revenue is simplistically cut by 6% EPS cut by 18%. When I look at second quarter margins, it was pretty impressive despite the revenue miss. I'm curious why it looks like no incremental cost actions are being contemplated despite the revenue cut. Just walk us through your thought process on cost actions.

Just a couple of things to unpack there, Vijay. First of all on the sales versus the EPS revision in the total year guidance, at the midpoint, it's roughly $0.20 or $0.24. I'd say that 60% of that is just from the top line. I mean at the midpoint, there's probably $400 million or so sales coming out. If you take that out at the margin rate, that gets you about 60% of that. The balance is the combination of lower gross margin rate because as Michael talked about, a fair amount of the sales reduction for the second half is in proprietary products which are margin-rich for us. You have maybe a 100-basis point pressure on the gross margin in the second half. Between those two, that's most of the EPS impact, a little bit of favorability on the TOE side like the SG&A probably $0.06 or so, with the balance being noise between tax and interest. It's primarily top line driven, a little bit of gross margin rate and offset by productivity. So we do have productivity, additional productivity coming through. When you look at the second quarter, we were down on the margin rate, probably had 350 basis points of pressure from the top line, just the volume as well as the margin rate from the higher proprietary products coming out. But you did see some nice offsets on the SG&A side as well as some other productivity initiatives in the supply chain that helped us offset that and deliver the 19.7%. I would say those same factors are in play for the full year guide. While we still expect that adverse mix impact that I talked about, we will continue to get productivity offsets. In my commentary, I mentioned that we have doubled down. We already had coming into the year a number of different specific productivity projects on top of what we normally do around productivity site closures and delayering and so forth. Additionally, we've identified opportunities, as you would expect; Michael's got the team going after discretionary spend and some other productivity actions. I'm pretty confident that the margin rate will be able to offset some of that top line.

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

Great. Thanks for the question. Just a couple of clarifications here, Michael and Tom. Can you provide us with an update on the actual destock dollar in 2Q and now what you are expecting for the second half? Because you guys saw it before everybody else, so we thought that you would see it alleviate before everybody else. So just give us an update on that please?

Yes. Good morning, Luke. Good to hear from you. As we have talked about in previous quarters, we've been seeing somewhere in the order of 500 basis points to 600 basis points of destocking in our business. I think that's consistent with our experience in the second quarter. We have a new variable, a new dynamic though that is making it difficult to give a precise number for destocking as we move into the second half of the year because we're also starting to see, or we did see, a deceleration in just overall demand within the bioproduction space linked to a more cautionary approach and a push out of some of the projects and campaigns. So at this stage, it is difficult to parse that between demand versus destocking since it's pretty widespread at this stage. But I would point you to the data that we have on our customers' overall inventory health. This is something that we've been really close to for nearly a year now, and what we're seeing there is continued improvement. The survey data and the feedback from our customers continues to trend in the right direction. When I look at where our customers' inventory is of these destocked categories or these overstock categories and how they're thinking about forward demand, it is encouraging. When I look at the category that was most overstocked in bioproduction, it was in our single-use platform. I referenced in my commentary one of the leading indicators that we look at in that particular business is overall engineering drawing activity. That's a critical leading indicator within our single-use platform. We saw a market uptick in engineering activity in the second quarter and that will take time to convert into orders, and there is a lead time on the back of that to get into revenue. But that is another signal that gives us some encouragement as we think about our current environment.

All right. Great. I have two quick follow-ups. When you mention engineering drawing, I have to admit I’m not familiar with what that entails. Could you clarify when you expect engineers to start creating plans and the anticipated timeline for placing orders for drug manufacturing? Additionally, regarding the improved inventory surveys you mentioned, have you factored any of that into your guidance, or could this data potentially bring in some positive surprises for the latter half of the year?

Great question, Luke. On the engineering activity, as we talked before, our single-use platform is a custom platform where we're designing custom assemblies and manifolds and connectors. Every opportunity that we have with our customers is unique and requires custom engineering. They'll come to us with a request for a design. Our engineers will collaborate on that design, and ultimately it will translate into an order. That process can take a few months before an order is ready. Depending on the specifics, we have lead times that could be in the two to three-month time frame for building those products. I hope that gives you some clarity on what that would look like on a leading indicator basis. The positive signals we've talked about are based on the conditions we experienced in the second quarter, and we've extended those through the second half of the year. Thus, anything material that improves or worsens won’t size into our current numbers.

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

Hi, everyone. Michael and Tom, good morning. I appreciate you taking my question. I have one regarding revenues. What were the figures for China in the last quarter? You mentioned that the guidance for the second half is based on trends from the second quarter. I'm interested in July, as it appears to align with the second quarter regarding the phasing. So, considering the exit rate in July, are we seeing an improvement compared to June, or are we at June's levels?

Hey, good morning, Vijay. Thanks for the questions. On China, we have been clear that we don't have significant exposure there; it's only a few percent of our overall revenues. The trends we saw in the second quarter echo what you've heard from others: it is weak and not particularly constructive right now. This is reflected in our overall performance in the EMEA region as well. With China contributing to overall weakness, we also have semiconductor headwinds in that region, which are key drivers for EMEA's performance. However, there are positive signals from our Bioproduction business in Korea and Southeast Asia, where we continue to see strong core organic growth. As for July, we did see sequential weakness reflecting what we observed toward the end of the quarter. It seems prudent, given the current climate, to expect that the trends from Q2 will continue through the rest of the year.

That's helpful, Michael. And Tom, wishing you all the best in your transition. I have a follow-up on the margin question for you here. Revenue is cut by 6%; EPS is cut by 18%. Looking at the second-quarter margins, they proved quite impressive despite the revenue miss. I'm curious why it appears that no incremental cost actions are being contemplated despite the revenue cut. Can you walk us through your thought process on cost actions?

Sure, Vijay. Just a couple of things to unpack there. On the sales versus the EPS revision in the total year guidance, at the midpoint, it's roughly $0.20 or $0.24. I'd estimate that about 60% of that is purely just from the top line. I mean at the midpoint, there's perhaps $400 million or so being removed from the sales total. If you account for that at the margin rate, you get about 60% of the EPS reduction right there. The balance comes from a lower gross margin rate, because as Michael mentioned, a significant portion of the sales reduction for the second half pertains to proprietary products which are margin-rich for us. We expect a roughly 100-basis point pressure on gross margin in the second half accounted for. Between all this, that explains the bulk of the EPS impact, but we have productivity and additional savings to bolster our business. If you check the second quarter, we faced around a 350 basis point reduction in margin primarily from the drop in top-line volume and the margin rate from the higher proprietary products. Meanwhile, we have seen satisfactory offsets in SG&A, plus we initiated some productivity measures in the supply chain, all of which helped deliver the 19.7%. Those factors, sustaining through our full-year guide, while we expect adverse mix impacts to manifest, we will continue to implement productivity measures. My commentary earlier reflected our commitment to continuous improvement—Michael's introducing additional measures addressing discretionary spending and other productivity initiatives. Therefore, I am optimistic regarding our margin trajectory amid these revenue adjustments.

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

Great, thanks for taking my question. Just a couple of follow-ups here, Michael and Tom. Can you provide us with an estimated destock dollar amount in 2Q and what your expectations are for the second half of the year? Given you were early to see these trends, have you anticipated a potential easing of the destock pressure now?

Yes, good morning, Luke. Regarding destocking, as previously mentioned, we observed approximately 500 to 600 basis points of destocking in our operations. This aligns with our experience in 2Q. However, a new dynamic entering the second half makes pinpointing destocking numbers more challenging, as we noted weakening demand within the bioproduction space. Furthermore, we have observed notable improvements in overall inventory health, with positive trends reflected from customer engagements. Our order book remains healthy, particularly in the single-use sector. We've seen an uptick in engineering activity, a key leading indicator suggesting future demand, supporting a somewhat optimistic outlook amidst the demand and destock challenges.

All right, great. And just two quick follow-ups—can you provide a timeline for when you see these engineering drawings and when they translate into order placements and manufacturing? Also, have any of the improvements factored into your guidance, or could they provide potential upside through the rest of the year?

Regarding engineering timelines, the entire process from initial request to final order placement takes time; typically a few months will elapse from when engineers begin their designs until orders are ready. We've observed positive data from our customer inventory surveys, bolstering an optimistic outlook without factoring in all potential improvements within our current guidance.

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

Hi, guys. Michael and Tom, good morning. Thank you for taking the question. In regards to revenue, could you provide some insight into how China performed in the quarter and comment on the outlook for the back half of the year as it's factoring into the overall performance?

Good morning, Vijay. To clarify, we have minimal exposure to China, constituting about a few percent of our overall revenue. The trends observed in Q2 have been consistent with other reports, showing a weakness in that market. This has impacted the overall performance of the EMEA region and reinforces the semiconductor-related challenges we're navigating there. However, our Bioproduction business continues to see robust growth in other areas like Korea and Southeast Asia, which is encouraging.

Thank you, Michael, and Tom, good luck as you transition. Just one more on the margin question: with an anticipated revenue reduction of 6% and a larger EPS reduction, how does this impact the second-half margins, especially given that you managed to maintain impressive margins amid previous misses?

Vijay, great question. In terms of the guidance cuts, the reduction in sales has directly correlated to the EPS decreases. At the midpoint of our guidance, we’re experiencing about $0.20 to $0.24 less on EPS due to the revenue shortfall, which contributes approximately 60% to that figure. The remaining declines in EPS can be attributed to a lower gross margin rate stemming from decreased sales in high-margin proprietary products—leading to around a 100-basis point pressure on gross margins for the rest of the year. The mix is also considered, contributing further to our margin adjustments.

Our next question comes from the line of Rachel Vatnsdal with JPMorgan. Rachel, please go ahead. Your line is open.

Great, good morning. Thanks for taking the questions. I wanted to follow up on your comments regarding the allocation within the guidance cut. Earlier you stated that a portion of the guide cut was attributed to instrumentation and equipment. Could you walk us through where pricing stands for the back half?

Our pricing environment remains relatively healthy, although it has moderated compared to 2022. We expect to see normalized pricing, while still benefiting from a little higher price setting than historical trends. Overall, we’re optimistic as we have performed consistently in this domain while balancing the cost pressures faced.

Thank you, everyone, for your questions. I will now turn the call back over to Michael Stubblefield for closing remarks.

Thank you all for participating in today’s call. I look forward to updating you in the next meeting. Until then, be well!

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