Avantor, Inc. Q3 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 Third Quarter 2023 Earnings Results Conference Call. I will now turn the call over to Christina Jones, Vice President of Investor Relations. Mrs. Jones, you may begin the conference.

Good morning. Thank you for joining us. Our speakers today are Michael Stubblefield, President and Chief Executive Officer; and Brent Jones, Executive Vice President and Chief Financial Officer. The press release and a presentation accompanying this call are available on our Investor Relations website at ir.avantorsciences.com. A replay of this webcast will also be made available on our website after the call. Following our prepared remarks, we will open the line for questions. During this call, we will be making some forward-looking statements within the meaning of the Federal securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings. Actual results might differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of the date that they are made. We do not assume any obligation to update these forward-looking statements as a result of new information, future events or other developments. This call will include a discussion of non-GAAP measures. A reconciliation of these non-GAAP measures can be found in the press release and in the supplemental disclosure package on our Investor Relations website. With that, I will now turn the call over to Michael.

Thank you, CJ, and good morning, everyone. I appreciate you joining us today. I'm starting on Slide 3. Third quarter business results were in line with our guidance across all key financial metrics, including core organic revenue contraction of 7.9% and adjusted EPS of $0.25. As anticipated, market conditions in the third quarter were similar to the conditions in the second quarter, as inventory destocking and cautious customer spending continued to impact demand in our Biopharma, Healthcare and Advanced Technology and Applied Materials end markets. These headwinds were partially offset by continued strong growth in sales to our higher education customers and in our biomaterials platform, where we delivered another quarter of double-digit growth. Sales of bioproduction materials for cell and gene therapies was another 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 million of debt year-to-date as free cash flow conversion in the quarter exceeded 110%. Winning several new customer contracts and renewals in Biopharma, Education and Healthcare, as a result of our strong competitive position and enhanced commercial intensity. Continuing to add innovative proprietary products to the portfolio with our Avantor magnetic mixing system for single-use mixing needs and J.T. Baker MCA tips for the Tecan Fluent Handling platform. In addition, we generated strong momentum with Oxford Nanopore, one of our strategic suppliers for cell and gene therapies. Launching our Scientific Advisory Board led by Dr. Ger Brophy, including experts in biologic manufacturing and technology, chemistry and gene therapy, who will guide our research and development efforts and leveraging our Avantor Business System to continue executing on our productivity initiatives. Looking ahead to the fourth quarter, we are assuming that the demand trends we have experienced over the last couple of quarters continue. Although, activity levels remain strong and overall inventory health is improving, we have not yet seen a change in order patterns. Nevertheless, customer sentiment does seem to be improving, and we remain bullish on our outlook for the mid to long term, given the strength of our platform and overall market positioning. Before I turn the call over to Brent, I remind you that he joined us in early August as part of our previously announced CFO transition. In the relatively short time that he has been with us, he has onboarded quickly and has already proven to be an excellent partner to me and to our leadership team as we work together to advance our growth strategy. With that, let me turn it over to Brent to walk you through our third quarter results in more detail.

Thank you, Michael. Good morning, everyone. Before I take you through our third quarter results, I would like to share some early observations. I know our end markets well from my days at a previous corporation, and I'm thrilled to be back in a company like Avantor that is so well positioned to benefit from the long-term secular growth opportunity that these markets offer. That said, my excitement is about much more than the end markets. I'm very impressed with what the team has been able to build at Avantor. We have an incredibly strong foundation and the right core capabilities and talent to drive the growth and margin capture you have come to expect. I also believe that Avantor is unique within our space; the combination of our world-class channel and leading proprietary consumables portfolio is compelling. These make our revenue base both highly recurring and resilient and we've shown the ability to convert strongly to cash, no matter the weather. Finally, our capital intensity is relatively low. To me, this is a proven recipe to generate significant shareholder value. We do have work to do on business insights, capital allocation, and business optimization. Part of what attracted me to Avantor is the opportunity to build on our strong foundation and leverage my operational experience to accelerate growth and performance. I'm excited for what is ahead and look forward to helping lead us through the next chapter. Now moving into the third quarter numbers on Slide 4. Reported revenue was $1.72 billion for the quarter, while revenue declined 7.9% on a core organic basis, it was essentially flat on a sequential as reported basis, consistent with what we told you in July. The organic background has remained relatively static. We are navigating an environment with ongoing destocking and demand weakness in Biopharma, as well as continued softness in the Advanced Technologies and Applied Materials end markets. We were encouraged to see modest incremental sales improvement at the end of the quarter from our semiconductor customers suggesting that our OEM customers' 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. Finally, we saw another strong quarter in Higher Education in the Americas, where we've seen a significant pickup over the last six months. Adjusted gross profit for the quarter was $579 million, and our gross profit margin was 33.6% in line with last quarter on an absolute and rate basis. Year-over-year, our gross profit was impacted by lower sales volume, mix, inflation, and negative fixed-cost leverage. However, we were able to partially block these effects with our productivity efforts both on Plant 4 and through targeted supply chain efficiencies. Adjusted EBITDA was approximately $318 million. Our Q3 adjusted EBITDA margin of 18.5% was in line with our expectations for the quarter. Year-over-year, our EBITDA margin performance was impacted by lower gross profit and negative fixed-cost leverage on SG&A. We are working aggressively to offset these headwinds with productivity initiatives. Interest and tax expenses were in line with our expectations. As a result, adjusted earnings per share came in at $0.25 for the quarter, reflecting the flow-through of adjusted EBITDA performance. Moving to cash flow, we generated $193 million in free cash flow, reflecting more than 110% conversion of adjusted net income in the quarter and approximately 95% on a year-to-date basis. Our Q3 performance was enhanced by continued disciplined working capital management. Our adjusted net leverage ended the quarter at 3.9 times adjusted EBITDA, and we have paid down over $650 million of debt this year, which represents a 10% reduction in total debt. Deleveraging remains our top capital allocation priority, and we continue to target an adjusted net leverage ratio below 3 times. Slide 5 outlines the components of our third quarter revenue performance. Core organic revenue declined 7.9% in the quarter. COVID-related revenues represented an approximately 1.7% headwind for the quarter, reflecting the expected roll-off of approximately $30 million of COVID-related sales from the third quarter last year. Net-net, this resulted in a 9.6% organic revenue decline. Foreign exchange translation represented a 2.3% tailwind, driven by a modest appreciation of the EUR resulting in a reported revenue decline of 7.3% for the quarter. On to Slide 6. From a regional perspective, the Americas declined 7.9% on a core organic basis, largely consistent with Q2 as we continue to experience pressure in the Biopharma and Advanced Technologies and Applied Materials end markets. Our increased commercial intensity in Education and Government is driving share gains and led to the third consecutive quarter of growth with higher education growing high-single digits in the quarter. In addition, biomaterial sales increased double-digits, driven by strong demand for our custom formulated silicone solutions in medical implants and healthcare applications. Europe declined 8.6% on a core organic basis in the quarter, consistent with our expectations. On a year-over-year basis, Europe's performance was again driven by weakness in the Biopharma and Healthcare end markets, with softer demand for lab consumables and single-use solutions driven by ongoing destocking. AMEA declined 5.4% on a core organic basis in the third quarter, driven by declines in lab consumables and single-use solutions, as well as formulated solutions for our semiconductor customers. Despite the macroeconomic challenges, particularly in China, our business saw solid growth in bioproduction process ingredients, services and biomaterials. Slide 7 shows our core organic revenue change for the quarter by end market and product group. Biopharma, representing almost 55% of our annual revenue, declined high-single digits with similar performance in both research and production. In the research environment, we saw a continuation of the conservative approach to customer spending that we witnessed in the second quarter. This is negatively impacting activity levels at research labs and constraining capital purchases, putting pressure on both consumables and equipment and instrumentation sales. Sales to mid-cap and large-cap pharma customers appear to have stabilized relative to last quarter and the sales rate to our biotech customer base has been relatively consistent since the beginning of the year. While spending is constrained, customers continue to advance meaningful R&D pipelines and fund promising science. In the production environment, sales were similar to our second quarter results as demand continues to be impacted by inventory destocking and customer campaign delays. However, the environment does seem to be stabilizing, and we continue to see encouraging signals from our customers. Anecdotally, inventory health continues to improve and single-use engineering drawing activity remains strong. Our focus on cell and gene therapy is paying dividends, yielding double-digit growth in several critical product lines targeting these workflows. We are confident that these signals will translate into improved order book trends and sales in the coming quarters and continue to have high conviction in the fundamental drivers within 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 third quarter, the third consecutive quarter of growth, driven by high-single digit higher education growth in the Americas. We are encouraged by our recent commercial wins and the supportive funding environment and expect continued momentum in this platform. Advanced Technologies and Applied Materials, representing approximately 25% of our annual revenue, declined low double-digits on a core organic basis in the third quarter, driven by declines in the Americas and AMEA, largely attributable to inventory destocking at our semiconductor customers. However, there are early signs that OEM inventory health is improving, and we are beginning to see modest sequential improvement in the outlook for this business. By product group, Proprietary Materials and Consumables offerings were down low double-digits in the quarter, with destocking and reduced demand for bioproduction and formulated solutions for semiconductor customers partially offset by strong biomaterial sales. Sales of third-party materials and consumables declined high-single digits, impacted by continued destocking of lab consumables and reduced demand across research settings. Services and specialty procurement, which integrate us directly into our customers' critical operations, grew mid-single digits for the third consecutive quarter, while equipment and instrumentation declined high-single digits, reflecting constrained capital spending in the current macro environment. Slide 8 provides an update on our full year guidance. As Michael noted in his overview comments, the backdrop for Q4 is relatively consistent. So in terms of our full year outlook, we're maintaining our revenue guidance but tightening our range around the midpoint, adjusting our margin expectations and raising the midpoint of our free cash flow guidance. To get into specifics, we expect full year core organic revenue growth of negative 6% to negative 5% and organic revenue growth of negative 8.5% to negative 7.5%. In each case, this tightens our range but retains the same midpoint. After accounting for a 50 basis point tailwind from FX, we anticipate full year 2023 reported growth of negative 8% to negative 7%. This tightened guidance reflects the themes we've discussed so far this morning. We continue to perform solidly against the end market backdrop, and things appear to have stabilized, evidenced by our sequential performance and expectations, but have not yet shown significant signs of improvement. Our long-term bullishness remains intact and is well supported by the markets we serve, but the near term remains challenged from a growth perspective. While top line is behaving as expected, we are facing some margin headwinds. We now expect adjusted EBITDA margins of approximately 18.5% to 18.8%, lowering our midpoint by about 50 basis points. This is due to incremental pressure from manufacturing absorption, inventory charges, and modest mix impact from growth in the lower-margin education end market. Interest expense and tax expectations are unchanged from our Q2 update, so the resulting flow-through to adjusted EPS results in a revised range of $1.02 to $1.06, with the midpoint at the bottom end of our previous guide. We expect our strong free cash flow performance to continue. The working capital management you saw in Q3 will continue to drive strong conversion to cash. As a result, we are raising the midpoint of our free cash flow guidance; free cash flow for the full year is anticipated to be $625 million to $675 million. With that, I will turn the call back to Michael.

Thank you, Brent. It's great to have you here. Without question, we are operating in a dynamic environment. We are responding by driving initiatives to accelerate growth, enhance productivity, and control costs, which together will put us in an even stronger position when the end markets turn. We're also in the midst of the Golden Age of scientific discovery, driven by rapid innovation and the promise of new biologic therapies that have the potential to change lives. There are currently more than 260 Phase II clinical trials in gene therapy underway. More cell and gene therapies are expected to be approved in 2023 than in the past five years combined, and the Nobel Prize-winning research led by Katalin Kariko and Drew Weissman has opened up a whole new field of synthetic biology. I know I speak for our leadership team in expressing our deep sense of responsibility and pride for the role we play in helping to set science in motion. I'd like to thank our associates for their commitment to our mission and for their focus on commercial and operational execution. Finally, I'll close with a reminder that we are hosting an Investor Day on December 8 at 9:00 a.m. at the New York Stock Exchange. We look forward to seeing many of you in person or on the webcast. I will now turn it over to the operator to begin the question-and-answer portion of our call.

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

Thank you. Congratulations on the quarter. Brent, it's nice to meet you, and I look forward to seeing you in person. Michael, let's start with bioprocessing, which is a significant aspect of your business. You have mentioned positive developments in stabilization and activity during this call. Could you give us an idea of the underlying growth rate for this quarter and your expectations for the fourth quarter? Additionally, as you consider your order book and the stabilization, what is your outlook for 2024?

Yeah. Good to hear from you, Dan. I hope you're doing well and thanks for the question. Bioprocessing is an important part of our business; as we've talked before, it's roughly 25% of our business or thereabouts. And I think we are encouraged that we seem to have hit the bottom here; 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 cell and gene therapy, where we had another really good quarter. I would say customer sentiment continues to be strong. The work that we do to understand inventory trends and production trends and such, I think all the signals are all pointing in the right direction, and certainly, the health of our customers' inventory is definitely improving. We talked last quarter a lot about some of the leading indicators for our single-use business, things like engineering drawings, and I continue to be encouraged by the strong level of activity that we see in that part of the business as well. And certainly, the pipelines continue to advance, and I would say the end market there continues to be quite solid. So we are continuing to be bullish about the mid to long-term prospects for that business. We're anxious to see order books turn as we indicated in the call, in our prepared remarks, we've not yet seen that happen, and we're certainly keeping a close eye on that, and I would anticipate that that would happen in the coming quarters. But the business is playing out about as we had anticipated, with relative stability over the last couple of quarters. And as we think about the quarter ahead in Q4, I think the way we've guided it is more of the same and a continuation of the trends that we've been seeing. As we think about 2024, it's a little bit early for us to call that. We're right in the middle of our annual planning process, and we'll take advantage of the next couple of months to put that plan together, and we'll be prepared to give our formal 2024 guidance when we get into our Q4 call in February. But as I think about bioprocessing as it relates to 2023, we've talked about our core organic growth rate being off mid to high single digits for the year, and that's my expectation. And when I think about that in the context of the broader space, I think you see the relevance and the positioning that we have here holding up well.

Thank you. As a follow-up, your smaller exposure in China and your focus on instruments is beneficial given the ongoing volatility there. Thermo mentioned that the end market is currently facing negative growth rates, which I assume will persist at least for the 2024 baseline. You seem more optimistic. I'm trying to understand if this optimism comes from a better mix, improved execution, or other factors. As we look towards 2024, even though you aren't providing guidance yet, should we expect stability in the first half and some improvement? Any insights on the addressable market and the demand trends you're observing would be appreciated. Thank you.

Thanks, Dan. I don't have specific insights on when we might see changes in the end markets. However, we are encouraged by the stability in the market and the improvement in customer sentiment. I'm not ready to make predictions for 2024 just yet, but we are optimistic about our current observations. Additionally, the actions we are taking are manageable, including our intensified focus on commercial efforts to drive growth and the cost-reduction strategies we are implementing. Our teams are putting in significant effort to engage with customers. We've also made important investments in our digital capabilities, which are facilitating more personalized marketing and large-scale campaigns that are gaining traction. Considering where we are and where we've been, our growth investments and cost control measures should position us to be stronger when the end markets eventually improve.

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

Hi, Michael. Good morning and thank you for taking my question. I wanted to discuss the margins, specifically for Q4. It seems there will be a sequential decrease of 100 basis points for adjusted EBITDA margins. Your revenues appear to be stable sequentially. Is this decrease related to gross margins, or are you anticipating an increase in SG&A in Q4? Any insights on what is impacting the Q4 margins would be appreciated.

Yeah. Happy to give you some color on that, Vijay, and thanks for the question. You are right. We are signaling a bit of incremental margin pressure as we work through the balance of the year here and have adjusted our full-year outlook by about 50 basis points or so. It is mostly a gross margin dynamic relative to a couple of key themes here. Firstly, hopefully, you noticed the strong free cash flow performance that we generated in the third quarter. And that continues to be an important area of focus for us as we think about managing working capital in this environment. And so part of what we're reflecting here in our margins is, again, strong focus on managing our own working capital and inventory levels and throttling back production levels incrementally, which is resulting in a bit more under absorption than what we had originally planned. We've all 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 in 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&A, particularly on a sequential basis as we think about maybe not some of the transactional FX tailwinds we saw in Q3 repeating and some one-time SG&A benefits that we saw in Q3 that we don't expect to repeat in Q4. But it's primarily all held up at the gross margin level, Vijay.

That's helpful, Michael. I noticed your free cash performance is certainly at the high end of the industry. If it's not about free cash, maybe Brent could address this. Brent, how should we approach 2024? I'm not seeking guidance; I'm just trying to understand the correct starting point. Should we base it on Q4 trends? Is that the appropriate starting point, or are there one-off items in Q4 that we should consider? I think it suggests adjusted EBITDA margins of about 17.5% or below. Is that the right basis to consider for next year?

Yes. One, good to speak with you. I think following on Michael's comments, it's too early to get to the exact jump-off for '24. We are in the middle of our budget process. There are so many puts and takes there. So I don't think it's the right time to make the call, but we'll be talking to everyone again soon. And we'll definitely go in our normal cadence and give you clarity in the months to follow.

Understood. Thanks guys.

Yeah.

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

Thank you. Good morning. Michael, I 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. I was just curious what you're seeing and what you're assuming kind of the fourth quarter?

It's great to hear from you, Jack. Thank you for your question. Looking at our recent results and reaffirming our guidance for the fourth quarter, we are observing the trends we initially mentioned back in the second quarter continuing through the latter part of the year. This includes the research environment in Biopharma. The funding challenges we faced earlier in the year in biotech seem to have reached their lowest point by the second quarter. We observed relatively stable revenue performance in that customer segment during the third quarter and expect something similar for the fourth quarter. On a positive note, there have been some encouraging developments in biotech funding over the last quarter or two that give us hope for that sector. We believe we have now reached stability in that area for the fourth quarter. In the mid- to large pharma sector, we are also starting to notice some cautious spending trends as we moved from the second quarter. This aligned with our expectations in the third quarter, and we anticipate these trends will persist into the fourth quarter. Beyond just funding and budget considerations, the promising scientific advancements being funded are key. The pipelines are quite strong, with several potential blockbusters advancing, and overall activity remains robust. As I’ve mentioned previously, the level of engagement we're maintaining with our customers over the past few months positions us well. As we approach year-end, our activity levels are the strongest they've been all year, allowing us to maintain a cautiously optimistic outlook as we conclude the year.

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

So as you know, the capital equipment 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 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. Our expectation is that continues into the fourth quarter. And of course, as we get into the fourth quarter, it's quite topical or timely to talk about year-end budget flushes, which is a dynamic that we would typically experience towards year-end, and it's primarily concentrated in this area of capital equipment as customers look to close out the year and use their available budgets. As we signaled in the second quarter and consistent 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 fourth quarter on a relative revenue performance, we would anticipate capital equipment spending in Q4 to be similar to what we saw in the third quarter.

Sounds good. Thank you.

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

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. 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 four 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 four quarters to get back to normal or is it going to move a little bit faster than that, just because once it's flushed out, it will come back quickly?

Right. I certainly understand the question, Michael, and we're as anxious as you are and everyone else is to 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 and weeks, we really don't have a crystal ball that tells us when these orders are ultimately going to turn around. And so we end up 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. As I look at the feedback that we've aggregated here coming out of the third quarter 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. Undoubtedly, inventory levels are improving. Many customers are 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 '24 when we get into February.

Okay. Fair enough. Just to follow up on your point about the short cycle nature of the business and the limited visibility, there have been many updates in Biopharma over the past few months, including significant cuts and reorganizations. The Pfizer announcement a couple of weeks ago was particularly notable. Can you compare that with your comments on improving tone and sentiment? Have you been experiencing some of these cuts in pharma for a few quarters now, making it not particularly new, or why doesn’t that align with what you're hearing from your customers currently?

I think that's the right way to think about it, Michael. 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. So 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 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 offering into that space. So yes, I think the way you’re thinking about it is about right. These are not incremental to what we’ve already been experiencing the last couple of quarters.

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

Hey, guys. Good morning. Thanks for taking the questions. Brent, maybe one for you on the margin side. I'm just trying to get a little more granularity in terms of the moving pieces for 4Q. 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 $12.5 million? 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.

Yeah. I mean, thinking about one-timers versus on a rate basis, absolutely for sure, absorption is an issue. You always have to manage as Michael indicated there. I mean that will depend a lot on the go forward, but we're pretty tight attention to that. So I think that has a decent 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’d put to one-time and the rest of it is real based on the underlying activity.

Okay. That's helpful. And then, Michael, maybe a similar vein, just on the pricing outlook. You mentioned some of the 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?

So pricing for us has been relatively stable throughout the year. We did our customary increases early in the year and have been, quite frankly, pleased that we haven't had to go back to the market multiple times this year. I know our customers appreciate 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 underpins our long-term growth algorithm. So as I think ahead to the pricing environment, I would say it's constructive. And ultimately, as we think about the actions we'll take next year or going into next year, it's going to somewhat depend on where inflation starts to settle out. 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.

Understood. Thank you, guys.

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

Perfect. Thank you for taking the questions. So I want to ask about Healthcare, just given the high-single digit decline was stepped down from the mid-single digit growth in 2Q. So you planned some biomaterial strength, but that was more than offset 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 are you expecting Healthcare to return to growth into 4Q and beyond?

Thank you for the question, Rachel. You’re quite perceptive. Our Healthcare platform, which represents about 10% of our total revenues, consists of a couple of components. More than half of the revenues come from the content we provide to our diagnostic customers, while around 40% comes from our biomaterials platform, which has been a strong performer for us throughout 2023, delivering another quarter of strong double-digit growth. I remain enthusiastic about the innovation and positioning of our technology in this area and expect that momentum to continue. The challenge in the third quarter wasn't related to relative revenue; it aligned with our guidance. However, we faced a year-over-year comparison issue. Looking back to the third quarter of last year, particularly with our Ritter business, we anticipated considerable revenues that ended up coming into Q4 instead, due to shipping deadlines met in Q3. This resulted in an unusually strong performance from our Ritter platform reported in the Healthcare segment during the third quarter last year. That was more about timing than underlying demand. This is the main factor affecting the reported percentages, and we expect a return to a more typical performance in the fourth quarter. To be clear, this segment performed as we had expected.

That's helpful. Thanks. I wanted to follow up on Dan's question to delve deeper into 2024. As Dan mentioned, one of your peers indicated earlier this week that they expect market growth next year. Your previous long-term core growth guidance was somewhat unclear. Given your peer's comments about market declines, should we expect a decline in Healthcare for you next year on a core basis? Or, considering your minimal exposure to China and reduced COVID-related challenges, is it feasible for you to achieve top-line growth next year?

Yes. So firstly, I’m not sure it’s especially productive for me to try to unpack the comments that one of my peers has made. I would caution just to try 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. So it's probably hard for us to try to reconcile how others might call market growth for next year. 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 see 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 also a real positive and strength for our platform. 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. The underlying demand in our end markets is stronger than what we’ve been realizing given that inventory drawdown. And then the last thing I would just reiterate is the sentiment is improving. I like our positioning; I like the funnel of activities that our teams have been able to build, and we’re anxious to see the order books turn, which will give us a bit more clarity on the shape of 2024 but probably a bit early for us to call that or give any more clarity from where we sit.

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

Great. Thanks. Good morning. Brent, welcome aboard. You certainly joined during an interesting time. So I guess I just want to follow up here on the 4Q margin. If we back out the inventory in your commentary on that, is it safe to assume that you guys would have been 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?

I believe you're getting close to understanding by excluding the one-time items. We're not making any predictions for 2024 at this point. Michael has provided some insightful comments on the matter. We will provide more details in the future, but I want to clarify that we have not made any commitments for 2024 yet. There are numerous factors to consider, including volumes and absorption along with growth in other areas, making it a complex situation. Given just one quarter following a difficult period, I don’t want to influence your thoughts on 2024 too early.

Thanks for that. Could you share your thoughts on the discussions you’re having with Biopharma customers? I assume you're not anticipating a significant budget influx. Are the conversations indicating any delays, or are pharmaceutical companies beginning to engage more with you about projects that might start next year? This is somewhat related to Ryskin's question about the trajectory. If there’s increased interest from pharma and quicker decision-making, that could give us a more optimistic outlook on the recovery aspect.

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. Certainly, that would be upside to our current plan if it were to occur, but we don't really anticipate it. For us, this topic of budget flush really is concentrated on our Equipment and Instrument category, which is less than 15% of our revenues, so not the primary driver of our business. But as we talked 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 quarters or 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 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. And as these inventories are normalizing, we will not only benefit from a higher level of activity, but certainly, we will also be able to capture the underlying demand that's been satisfied here over the last year or two with the inventory. So our customers continue to be quite encouraged, I would say, by what they're working on. The end market demands and themes continue to be quite strong. And I like our positioning. 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.

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 spend hit especially hard by biotech funding constraints. Other suppliers have recently lowered their long-range plans in the past two months, and you sound very bullish. So I'd love to learn more about your thinking.

Yeah. So when I talked about the optimism around cell and gene therapy and the impact that had on our third quarter results, I'm really talking about the commercialized platforms that are in the market that are being produced today. There is, I would say, incremental traction in that area. There's been a number of approvals this year. 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 won as we've run our model here and collaborate with our customers is resulting in strong double-digit growth of that platform. When I look at the pipeline, which is driving our R&D activities, the pipeline has never been stronger either. Are there customers that are optimizing and programs 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, I mean their way through the pipeline here, the curve is accelerating meaningfully. We have a relevant offering, and this is going to be an 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 ultimately 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.

That's helpful color. And a follow-up on bioproduction more broadly. Are you seeing any differential trends across your product 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?

We're observing comparable trends across our offerings. You mentioned our process ingredients, excipients, and chromatography resins, and we're experiencing some challenges in those areas. This isn't due to inventory issues; rather, it stems from our customers managing their end product revenues, which has led to delays and adjustments in their production schedules. Additionally, we're facing challenges in the single-use segment, where we're impacted by the same headwinds affecting our process ingredients business and the ongoing inventory stocking situation we've previously discussed. However, I wouldn't highlight any significant differences among the various components of our portfolio. On a positive note, the engineering activity that generates our single-use orders remains robust. Looking ahead to 2024, our customer forecasts indicate that this sector is expanding. Our team recently engaged with customers in Asia, and the growth they are reporting is quite impressive. We ended another strong quarter in Asia for bioprocessing, excluding China, which is typically modest for us. Overall, there are several encouraging signs in this sector that suggest better days are on the horizon.

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 the numbers around where that is today based on your surveys or conversations with customers and how that metric has trended throughout the year?

Yeah. Happy to do so. When we first started to look at inventory health and trying to really get insights 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 within single-use that were reporting excess of a year's 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. 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 three 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 three months, if not already where they want to be, is another data point fueling our optimism for a recovery here in the coming quarters.

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 have the items that didn't see stocking performed? And what does that tell you in terms of underlying activity levels?

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 were really linked to 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 third quarter, and our anticipation is that continues in the fourth quarter as well, and certainly how we've guided the quarter. So I wouldn’t say that the spread has changed as we’ve moved through the third quarter or into the fourth quarter. I think we’re – the way we’ve called this here, as you see us reaffirming our revenue guidance, has things relatively stable at the moment.

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

All right. Yeah. Thank you all for participating in our call today. We certainly look forward to updating you at our Investor Day on December 8. I hope many of you can join us at that event, and until then, be well, everyone.

Thank you, everyone.