Earnings Call Transcript - AVTR Q2 2021

Operator, Operator

Good afternoon. My name is Brain, and I will be your conference operator today. At this time, I would like to welcome everyone to Avantor's Second Quarter 2021 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I will now turn the call over to Tommy Thomas, Vice President of Investor Relations. Mr. Thomas, you may begin.

Tommy Thomas, Vice President of Investor Relations

Good morning. In light of the significant overlap of earnings calls in the life science space during our previously announced time, we made the decision to adjust the timing of our call to better accommodate the investment community. We appreciate your flexibility and thank you for joining us today. Our speakers today are Michael Stubblefield, President and Chief Executive Officer; and Tom Szlosek, Executive Vice President and Chief Financial Officer. A press release and a presentation accompanying this call are available on our investor website. A replay of this webcast will also be made available on our website after the call. Following our prepared remarks, we will open up 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, whether as a result of new information, future events and developments, or otherwise. This call will include a discussion of non-GAAP measures. A reconciliation of these non-GAAP measures can be found in the appendix to the presentation. With that, I will now turn the call over to Michael.

Michael Stubblefield, President and CEO

Thanks, Tommy, and good morning everyone. I appreciate you joining us today. I'm starting on Slide 3. As you're seeing from our press release, we had an outstanding second quarter that reflects strong momentum across each of our end markets and highlights our team's continued track record of execution. In the second quarter, we achieved 20.5% organic revenue growth and our core growth rate improved for the fourth consecutive quarter to 18.5%. COVID tailwinds contributed approximately 2% to growth, driven largely by sales of raw materials and single-use solutions for COVID vaccine production. In addition to delivering exceptional top-line results, we expanded EBITDA margins approximately 125 basis points, grew our adjusted EPS more than 80% to $0.35, and more than tripled free cash flow. We also realized incremental interest expense savings through successful term loan repricing actions. We continue to progress our long-term growth strategy and we're successful in closing two acquisitions in the quarter. In mid-June, we completed the acquisition of Ritter, which adds high precision proprietary consumables to our portfolio. And we recently launched Ritter's products under the J.T. Baker brand name through our differentiated customer channel. We also closed on RIM Bio, a China-based manufacturer of single-use solutions to support our bioprocessing platform. This acquisition extends our single-use manufacturing footprint to China and adds critical technology to our portfolio. The addition of RIM's manufacturing facilities doubles our single-use cleanroom capacity globally and enables Avantor to serve customers in the EMEA region with best-in-class times. Also of note for the EMEA region, we were recognized at the Korea Bioprocessing Excellence Awards in June for both our upstream processing capabilities and our single-use solutions, a nice validation of our bioprocessing offering and innovation capabilities. We continue to invest in biopharma production capacity to support the strong growth in our business. We completed several capacity expansions in the second quarter, including a single-use expansion of our facility in Devens, Massachusetts, the startup of a new single-use logistics facility in North America, as well as several expansion projects at our raw materials manufacturing locations in Aurora, Ohio, and St. Louis, Missouri. As we have discussed previously, access to early-phase research and discovery activities is essential to our business model and our sustained growth in the biopharma space. One of the ways that we access this customer segment is through our supplier agreement with the Biotechnology Innovation Organization known as BIO. BIO is the largest trade organization in the world that represents the biotechnology industry and gives us preferred access to more than 3,700 companies engaged in life science research. In the second quarter, we proactively extended our agreement with the BIO consortium through 2029. We also issued our inaugural sustainability report this month, a key milestone in our sustainability journey. I will talk more about this report in a moment. Looking ahead, we expect the momentum in our base business to continue driven by strong fundamentals across all of our end markets. Revenues in July have kept pace with first-half results and our order book for long-cycle proprietary materials continues to grow. We are again raising our 2021 full-year guidance, which Tom will cover in more detail later in our presentation.

Tom Szlosek, Executive Vice President and CFO

Thank you, Michael, and good morning, everyone. I'm starting on Slide 6. As Michael noted, organic growth was 20.5% this quarter, leading to year-to-date organic growth of 17%. Our core growth rate, meaning organic growth, less the estimated COVID tailwinds, rose from negative 8% in Q2 of last year to positive 18% in this second quarter, representing the fourth consecutive quarter of such acceleration. From a regional perspective, the Americas, which represents approximately 60% of global sales, reported 23.6% organic revenue growth in Q2 and sequential improvement in the daily rate of sales from the first quarter. End market performance in the Americas was driven by greater than 20% growth in biopharma, with our biopharma production sales growing more than 30% this quarter. Healthcare also had a strong quarter, growing above 30% driven by materials and consumable sales to hospital and clinical reference lab customers, as well as over 50% growth from our proprietary materials offering in the medical device space. Education and government grew double digits as university and research, and K through 12 activities resumed to more normalized levels. Advanced technologies and applied material sales were also up mid-single digits this quarter, reflecting the continued recovery of the industrial sector and strong growth of our proprietary materials for the semiconductor market. While all product lines in the Americas grew at double-digit rates, proprietary materials and consumables grew at double the rate of third-party materials and consumables. Europe, which represents approximately 35% of global sales, achieved 16.5% organic revenue growth driven by lab product sales, including materials, consumables, and equipment. All end markets in the region grew double digits with notable contributions from biopharma and advanced technologies and applied materials, where we've seen a pickup in lab and QA/QC activity. As was true in the Americas, sales of proprietary offerings grew faster than that of third-party driven by biopharma production, single-use assemblies, and medical-grade silicones used for implantable medical devices. EMEA, representing approximately 5% of global sales, achieved 16.4% organic revenue growth, driven by biopharma production and lab products. Sales of biopharma raw materials and single-use assemblies were particularly strong in China and Korea. Higher sales of lab consumables and equipment in India also contributed to EMEA's growth for the quarter.

Michael Stubblefield, President and CEO

Moving on to Slide 8. We achieved 34% growth in adjusted EBITDA and 125 basis points of margin expansion, from 18.5% to 19.7%, including over 50 basis points of gross margin expansion. All three segments achieved strong EBITDA margin expansion, reflecting productivity, commercial excellence, and a favorable mix contribution driven by our proprietary products, which are growing at nearly 3 times the rate of our third-party products. Adjusted earnings per share were $0.35, up 87% and reflecting strong operating performance and ongoing reduction in interest expense from our deleveraging and debt refinancing and repricing activities. Free cash flow, a non-GAAP financial measure, which we define as cash from operations excluding capital expenditures and one-time acquisition costs, was $265 million compared to $76 million in the comparable prior period. Growth was driven by EBITDA performance, working capital leverage, and lower interest payments, partially offset by increased CapEx to support our growth strategy. We have excluded approximately $25 million of one-time acquisition costs for Ritter and RIM Bio from free cash flow.

Tom Szlosek, Executive Vice President and CFO

Moving to Slide 9. As Michael indicated, we are raising our guidance for the year to reflect strong first-half performance, improving end markets, and confidence for the second half of the year. We now expect organic sales growth of 9% to 11% for 2021, which includes 1% to 2% from COVID-19 tailwind. Our overall guidance for COVID tailwinds remains unchanged at a range of $350 million to $450 million for the year. Consistent with our previous messaging on this topic, we believe vaccines will continue to grow in proportion to our total COVID-related tailwinds and we continue to forecast an overall decline in contribution from diagnostic product sales in the second half. Layering in projected impacts from FX of approximately 2% and M&A of approximately 2%, we are estimating total growth of 13% to 15% for the full year. Our growth in July remains strong and end market dynamics are favorable across the board. While we expect moderation in growth rates in the second half of 2021 given the strong comparables from 2020, the average two-year core organic growth rate, excluding COVID tailwinds, is expected to improve in the second half from 5% in the first half.

Michael Stubblefield, President and CEO

Thanks, Tom. I'm now on Slide 10. The relevance of Avantor’s business model and the importance of our mission is evident in our exceptional second-quarter performance and the overall momentum in our core business. We continue to execute well as evidenced by our margin expansion, EPS growth, and our free cash flow results. We remain committed to our growth strategy, including the ongoing integration of Ritter and RIM Bio. We’ll continue to focus on biopharma as a key growth driver for our company and will support our growth with ongoing investments in raw material and single-use manufacturing capacity. We’re also committed to advancing our sustainability initiatives through our Science for Goodness platform. As we look ahead, we are well positioned for continued growth across each of our end markets and expect to deliver strong results for the full year. The role of Avantor’s products and services in enabling scientific breakthroughs has never been more important. And one final note, before we conclude our prepared remarks. We are hosting a virtual Investor Day on Thursday, September 9 at 9:00 AM Eastern Time. Registration is live on our investor relations website, and we look forward to showing more detail about our business and our long-term growth strategy at this event. I want to thank you for your interest in Avantor and for your ongoing support.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.

Tycho Peterson, Analyst

Hey, good morning guys. Great quarter. That 30% growth in proprietary consumables certainly stands out, Michael. I’m just wondering if you could talk to that dynamic. Are there things you’re doing different from a go-to-market strategy to kind of drive the higher growth in proprietary products?

Michael Stubblefield, President and CEO

Yes. Thanks for the question, Tycho and good morning to you. You’re correct. Proprietary content is an important part of our overall long-term growth thesis. Historically, our proprietary content would grow at 2x to 3x the rate of our third-party content in our portfolio, and much of that is done to the fact that our proprietary content is preferentially oriented to our production platforms, which grow significantly faster than our R&D platforms. And I think what you’re seeing here is just the access that we have in early phase discovery and process development allowing us the opportunity to seed our proprietary content on more platforms than we have had historically. I think you’re really starting to see the benefits of our integration with VWR play out here. Our pipelines are fuller than they’ve ever been. We’re working on more opportunities than we’ve ever had. And I also think it speaks to the strength of our end markets. Clearly, within biopharma, the health and strength of the core monoclonal antibody business is clear as well as the emergence of several new exciting areas like cell and gene therapy. So we are leveraging the access that VWR gives us to our development partners and being very deliberate in seeding more content on more platforms. The impact, over time, will be to accelerate top-line growth and given the margins associated with our proprietary content, it will also lift our margins over time. Lastly, we're at the front end of our M&A strategy. We’ve talked a lot about our algorithm and our filter for screening acquisition opportunities. We will overweight the allocation of capital towards proprietary content, and that will accelerate growth and improve margins as we continue to drive higher proportions of proprietary content into our portfolio.

Tycho Peterson, Analyst

That’s a good segue to a question that I had on M&A. RIM Bio, I'm curious how material that is to your strategy for China? Can you talk a little bit more about the importance of that deal?

Michael Stubblefield, President and CEO

We’re excited about the opportunity to establish single-use manufacturing capacity in the region. Not only does it expand our presence, but it allows us to bring a business model with best-in-class lead times to a key long-term growth area for our business. We view this as something that we will build around. It gives us the manufacturing capacity for our single-use franchise with local capacity now in all three regions of the world, which we think is strategic. It also brought us some incremental technologies that we will leverage globally. So while modest in scale relative to the rest of the business, it is going to be meaningful to our China strategy. Although we’re in the early days here, customer response has been positive, and we’re busy seeding new opportunities and integrating that into our system.

Tycho Peterson, Analyst

Great. If I could ask one last one on just segments. You called out some government purchases around diagnostic supplies. I’m curious how material that was? Any segment level commentary for the back half of the year just in terms of mix?

Michael Stubblefield, President and CEO

Yes. I think the comments regarding government purchases were likely more of a comp issue as we think about trending over the last seven years. There were no significant PPE and diagnostic purchases from various governmental agencies. From an end market perspective, there is clearly a lot of momentum across all four of our key end markets, which we saw reflected in the growth we delivered in the second quarter. As we screen that through our outlook for the second half of the year, we've baked in the overdrive from the second quarter and have elevated our outlook for the core business, reflecting our view that we'll see continued momentum in these end markets. This is headlined by a strong environment for biopharma in both the R&D space and a vigorous production environment. Our open order book for our long-cycle proprietary materials is as strong as it's ever been.

Tom Szlosek, Executive Vice President and CFO

Just to add to what Michael said, you can consider for the full year guidance of 9% to 11%, that biopharma will be in the mid-teens. The second biggest segment advanced technology and applied materials will be now low to mid-single digits, and education and government will be mid-teens. The healthcare business should be in the double digits.

Derik de Bruin, Analyst

Hi, good morning. Tom, what would be the run rate for the net interest expense for the year?

Tom Szlosek, Executive Vice President and CFO

Yes. I think the run rate for Q2 should be pretty representative of the full year.

Derik de Bruin, Analyst

Got it. Thank you. Can you talk about what sort of the potential incremental revenue contribution from single-use capacity might be?

Michael Stubblefield, President and CEO

Derek, we've been pretty transparent about our investments across our biopharma platform. Our capacity expansions in single-use have dramatically increased in the U.S., a new site in Europe, and now the acquisition of RIM Bio in China gives us a solid foundation. The growth we are delivering in this area will be solidly supported by the investments we are making, necessary to fuel our sustained growth, particularly in biopharma. We have a series of expansions planned over the next few years, which supports our long-term growth algorithm and the guidance we provided today.

Doug Schenkel, Analyst

Good morning. On M&A, given your forecast, if we're looking at potentially $1 billion in free cash flow over the next six quarters, what’s your idea of capacity for M&A?

Tom Szlosek, Executive Vice President and CFO

Yes. Your math is somewhat accurate as we ended the quarter at 3.8x leverage. We continue to expect to be in the mid-threes or better by the end of the year. Suffice it to say that we think we have even more capacity now. And looking at the end of the year, the numbers you mentioned are quite obtainable given the deals we are targeting.

Doug Schenkel, Analyst

Okay. And about the proprietary content mix, how are margins evolving with that category?

Michael Stubblefield, President and CEO

Within our proprietary materials, the primary driver will be bioprocessing, which has considerable margins—also important is our medical-grade silicone platform for medical devices, which grew at nearly 50% in the second quarter. The margins from our proprietary content are generally higher compared to services, but can vary depending on the specifics of offerings.

Doug Schenkel, Analyst

How are you looking about operating leverage as things normalize?

Tom Szlosek, Executive Vice President and CFO

Yes, the 17% OpEx increase is in light of some performance-based incentives and will normalize in the second half. There will be some volume related costs, and we are mindful of inflation in our operating costs. Overall, we will continue to manage productivity and efficiency.

Vijay Kumar, Analyst

Congrats on a strong print here. Can you give insights into COVID tailwinds, especially the proportion coming from vaccines?

Michael Stubblefield, President and CEO

Thanks, Vijay. The overall outlook for the full year remains unchanged at a range of $350 million to $450 million, which implies roughly 1% to 2% contribution to our organic growth. Our view is that, ex the business, 40-50% comes from diagnostics and the remainder from vaccines. Diagnostics will substantially decline in the second half while we maintain strong visibility into our vaccine-related order book.

Vijay Kumar, Analyst

Any insights about the revenue back in 2022 tied to COVID vaccines?

Michael Stubblefield, President and CEO

We have good visibility through the first half of next year based on lead times. However, many variables could influence revenue for 2022, including the effectiveness of vaccines and the emergence of booster shots.

Patrick Donnelly, Analyst

Can you discuss the expansion opportunities in China? You mentioned some CapEx investments.

Michael Stubblefield, President and CEO

The key driver is the lack of penetration relative to peers. We see many favorable conditions for growth, particularly in biopharma. Our investments and strategy in China, particularly with RIM Bio, position us to capture that growth as the market develops.