Repligen Corp Q4 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to the Repligen Corporation’s Fourth Quarter of 2022 Earnings Conference Call. My name is Chuck, and I will be your coordinator. All participants will be in a listen-only mode. Please note that there will be a question-and-answer session following the company’s formal remarks. In order to accommodate all individuals who wish to ask a question, there will be a limit of two questions at that time. I would now like to turn the call over to our host for today’s call, Ms. Sondra Newman, Head of Investor Relations for Repligen. Please go ahead, ma’am.

Thank you, Chuck, and welcome everyone to our fourth quarter and year-end report. On this call, we will cover business highlights and financial performance for the three and 12-month periods ended December 31, 2022. We’ll also provide financial guidance for the full year 2023. Repligen’s President and CEO, Tony Hunt; and our CFO, Jon Snodgres, will deliver our report, and then we’ll open the call up for Q&A. As a reminder, the forward-looking statements that we make during this call, including those regarding our business goals and expectations for the financial performance of the company, are subject to risks and uncertainties that may cause actual events or results to differ. Additional information concerning risks related to our business is included in our quarterly report on Form 10-Q, our annual report on Form 10-K, the current report of Form 8-K which we are filing today, and other filings that we make with the Securities and Exchange Commission. Today’s comments reflect management’s current views, which could change as a result of new information, future events or otherwise. The company does not obligate or commit itself to update forward-looking statements, except as required by law. During this call, we are providing non-GAAP results and guidance. Reconciliations of GAAP to non-GAAP financial measures are included in the press release that we issued this morning, which is posted to our website and on sec.gov. Non-GAAP figures in today’s report include the following. Revenue growth at constant currency; gross profit and gross margin; operating expenses, including R&D and SG&A; operating income and operating margin; income tax expense; net income and earnings per share; as well as EBITDA and adjusted EBITDA. These adjusted financial measures should not be viewed as an alternative to GAAP measures but are intended to better enable investors to benchmark Repligen’s current results against historical performance and the performance of our peers when evaluating investment opportunities. Now I’ll turn the call over to Tony Hunt.

Thank you, Sondra. Good morning, everybody, and welcome to our 2022 year-end report. We are very pleased with the way the year played out, given the market dynamics in the bioprocessing industry, especially in the second half of the year, where we dealt with FX headwinds, changing order patterns, declining COVID vaccine demand, and cost inflation. We finished the year at close to $802 million in revenue driven by base business growth. Organically, our base business was up 35% in the quarter and 39% for the full year, while overall organic growth for the company was up 4% in the quarter and 22% for the year. Our Q4 sales were especially impressive, given we essentially recovered a $38 million drop in COVID-related revenue year-over-year with an increase in base revenue. For the year 2022, our overall business performance was outstanding, driven primarily by our filtration and chromatography franchises, which were up 23% and 45%, respectively. Within each of these franchises, our base business was up over 50%. Overall, our results demonstrate our ability to continue to differentiate ourselves in the bioprocessing market, which has allowed us to consistently grow above the market growth rate. As we progressed through the year, our product mix did change as COVID revenues declined, and this became one of the major drivers of margin performance in the fourth quarter, which I will discuss in more detail later... ...Before moving into the discussion of our Q4 performance and outlook for 2023, I want to highlight some of our key accomplishments and our progress against our five strategic priorities in 2022. Priority number one was advancing innovation. Over the last few years, we have focused on increasing the pace of R&D product launches to build on our foundation of disruptive and innovative technologies. 2022 was no exception, with our R&D team delivering 10 new products during the year. We launched four ARTeSYN systems, three filtration systems and one in chromatography, giving us a complete set of systems with low holdup volumes and a common software architecture. We are now well-positioned to sell our filtration and chromatography consumables and flow paths, which increases the recurring consumable stream for the company. 2023 will be about optimizing this portfolio to meet the needs of the mRNA and cell and gene therapy markets. The R&D team also delivered on an exciting and first-to-market downstream system, which we launched in Q4: the KrosFlo KR2i RPM System where RPM stands for real-time process management. This gives customers the ability to measure, monitor, and control drug concentration not only in real time but also in a fully automated way. We also leveraged our Avitide acquisition and developed and launched four affinity ligands and resins in 2022; three focused on AAV viral vector purification and one focused on monoclonal antibody fragment purification. Finally, we completed the technical launch of our next-generation large-scale GMP ATF controllers, providing our customers with a more automated solution for ATF applications. New products continue to have a very positive impact on our business. Products launched in 2021 and 2022 generated 7% of our revenues last year. We expect this number to jump to 14% here in 2023 for products launched since 2021... Our second priority was to build out our market presence in cell and gene therapy and mRNA. 2022 was a stellar year for us in cell and gene therapy. The business grew over 50% as our top accounts scaled and implemented Repligen technologies. We finished the year with well over 20 accounts generating greater than $1 million in revenues and over 350 active cell and gene therapy accounts. We also made inroads in the mRNA market, building off the success we had in mRNA COVID vaccine manufacturing. Our portfolio is well-positioned to capture share as this market grows and expands. And you can expect to see additional Repligen products hitting the market in 2023 and overall growth in cell and gene therapy of 15% to 20% coming off very tough comparisons in 2022... ...Our third priority was to integrate and support our fluid management acquisitions. The fluid management acquisitions that we made in 2020 and 2021 are now fully integrated with support coming from the build-out in 2022 of our assembly center in Hopkinton, Massachusetts, on the build-out of our Waterford, Ireland site here in 2023. We now have a dedicated management and commercial team, a growing portfolio of fluid management products that are synergistic with our systems strategy, and increasing awareness in the bioprocess community of our capabilities. We expect to build off the 30% organic growth we saw in the fourth quarter for fluid management and the 17% organic growth we saw for the full year 2022, which was hampered by the destocking on the component side. We expect to deliver 20% plus growth in 2023. This revenue will continue to be recognized in our filtration franchise. A fourth priority in 2022 was to pursue M&A opportunities and strategic partnerships to expand our portfolios and markets. Following on the string of fluid management acquisitions, we signed two important strategic partnerships with DRS Daylight Solutions and Purolite, which is now an Ecolab company last year. The DRS Daylight deal gives us another real-time in-line PAT technology that complements FlowVPX and puts Repligen in a leading position for advanced analytics and bioprocessing. The Purolite deal both extends our current partnership out through 2032 and expands our relationship to include new ligands developed by Avitide for mAb and mAb fragment markets. The resin products that combine our NGL ligands with the Purolite Jetted B technology continue to perform well in the marketplace. The combination of our partnership with Purolite and the content generated through Avitide and Navigo has helped us to transform our ligand strategy over the last five years. This puts us in a much stronger position to drive consistent high single-digit growth in this portfolio once we get through the final phase of Cytiva reductions here in 2023. And finally, our fifth priority in 2022 was to complete capacity expansion at three key facilities. Our assembly center in Hopkinton was completed in June and fully qualified in September. This gives us an important foundation to support increased demand for our flow paths and assemblies in the market, ultimately supporting our system strategy with recurring consumable sales. We also expanded capacity for ATF, flat sheet cassettes, hollow fibers, and systems at our Marlborough, Massachusetts and Rancho, California sites. It's been a key part of our business plan over the last three years to build out dual manufacturing capabilities that provide our customers with a robust business continuity plan. Over the last two years, we've increased our manufacturing capacity between three and nine-fold. We now have ample capacity for the next three to five years across the majority of our product lines. Here in 2023, we plan to complete the expansion of our customer application center in Waltham and to bring our Waterford assembly center online, further extending our dual manufacturing capabilities in fluid management. In addition, we're in the process of bringing additional ligand capacity online in Hopkinton and opening up a new facility in Estonia for our rapidly growing systems business. While our capacity investments will continue to impact our gross margins here in 2023 by 250 basis points, we believe it's important to have the business continuity foundation in place as we pursue expanding our market share in bioprocessing... Shifting now from our 2022 priorities and moving to our Q4 and full year business performance. As reported today, we had another strong quarter with base organic business up 35% and overall growth of 4% despite the $38 million COVID charge in the quarter. Within our franchises, our large scale OPUS chromatography columns, our filtration systems, our XCell ATF line, and our fluid management products were the major drivers of growth in base business performance for the quarter. From a market perspective, sales into gene therapy accounts were up over 35% in the quarter and over 50% for the full year, reinforcing our position in this market. COVID-related revenues contributed approximately 13% overall revenues in the quarter. COVID revenues were down approximately 20% sequentially from Q3 2022 and down 60% versus Q4 2021, as our main COVID vaccine customers lowered their demand... ...This ramp down in COVID demand in Q4, plus the increase in material costs and change in product mix where we had a lower contribution from proteins and filtration products and a much higher contribution from chromatography and fluid management products accounted for 450 basis points of the total decline in our gross margin, both sequentially and versus Q4 2021. For the year, COVID revenues were approximately $141 million or 18% of our overall revenues. We expect COVID revenues to continue to ramp down in 2023 to a range of $30 million to $40 million. The majority of COVID revenues are expected to be divided between the first and fourth quarters of 2023. Based on the anticipated drop of greater than $100 million in COVID revenues in 2023 along with the material cost inflation in manufacturing and the depreciation and occupancy costs associated with our new facilities, we will continue to see pressure on our gross margins. We do expect gross margins to recover somewhat from where we were in Q4 last year and are guiding now to a 53% midpoint for 2023. As our volumes increase and product mix shift to higher margin products, we will expect gross margins to improve in the second half of 2023 and expand by 100 to 200 basis points in 2024... ...On the orders front, in the fourth quarter, total orders were down 15% while non-COVID business orders were up slightly versus Q4 2021. Sequentially, in Q4 versus Q3, base business orders were also up slightly. However, we were very encouraged by some positive signs in the quarter. We had our strongest quarter for pharma in 2022 in Q4, as customers specified our products into late-stage commercial processes. We also saw a 25% step up in orders at our gene therapy accounts versus Q3. For the full year, total orders were down about 10% with base business orders up 15%. The areas where we continue to see order weakness is at the CDMOs and OEM customers. We saw some pickup in demand at CDMOs in Q4, but this was offset by a weaker Q4 for ligands as Cytiva continues to ramp down their demand as anticipated and the component side of fluid management business continues to work through elevated inventory levels that were built up during the pandemic. We believe that the order challenge is confined to CDMOs and OEMs, and that this will continue through the first half of 2023 with the expectation that we will move back to a growth mode in the second half of 2023... ...So moving now to franchise-level performance. Our chromatography business delivered outstanding growth, up over 75% for the quarter and 45% for the full year. Growth was driven by increased demand for OPUS pre-packed columns as resin availability improved, especially in the second half of 2022. We also saw OPUS revenues and orders pick up significantly at cell and gene therapy accounts. Large scale OPUS sales into these accounts were up more than 80% in the fourth quarter versus the prior year period. Orders were also strong with OPUS demand more than doubling versus Q4 of 2021. Although we saw a significant pickup in resin deliveries in the second half of 2022, the resin supply has softened here again in Q1 and remains tight. While resin lead times have come down versus 12 months ago, they are still elevated, which we expect will limit OPUS growth in the first half of 2023. We expect supply to open up in the second half of the year, as more capacity comes online. Overall, we expect growth for our chromatography business in 2023 of approximately 10%... ...Our proteins franchise had a lighter quarter in Q4, driven by decreased demand from Cytiva. The lower Cytiva volumes were partially offset by a strong demand for NGL ligands which we supply to Purolite. Overall, our proteins business was down 8% for the year, very much in line with our guidance to 2022. In 2023, we expect Cytiva demand to be down another 50%, which is in line with the contract we signed two years ago. We expect the lower revenues to be offset by strength in NGL ligand demand, growth factors, and our Avitide family of AAV resins. Overall, we expect proteins growth in 2023 to be flat. Our filtration franchise was down 10% for the quarter as this franchise absorbed $34 million of the $38 million drop in COVID revenues year-on-year. However, base filtration business was up 38% for the quarter, driven by strength in systems, ATF, and hollow fiber consumables. ATF had a stellar quarter and year, driven by success in commercial processes and the continued focus on new account development. Our filtration systems business also had a strong quarter and year as we are seeing traction with the new ARTeSYN kits developed and launched in 2022. Other key highlights in the quarter included the launch of our KrosFlo RS 20 filtration system for gene therapy, along with the launch of our GMP large-scale controllers for ATF. With an additional $100 million COVID challenge in 2023, we expect the filtration franchise to be down 4% to 12% overall, but up in the range of 10% to 20% for our base filtration business... ...Finally, our process analytics franchise had a softer quarter and relatively light year in 2022. In the quarter, we saw fewer year-end dollars for capital equipment versus prior years. Revenues for the year were up 11%. The pipeline of opportunities expanded in the fourth quarter and based on funnel strength, we expect 2023 growth to be in the range of 15% to 20% as we gain traction with our RPM platform and new products hit the market. In summary, we expect 2023 will be a challenging year for our industry as we all work through COVID headwinds and destocking challenges. Despite these challenges, I remain very optimistic about the bioprocessing industry and our position in the marketplace. Our investments support our commitment to stay ahead of demand and position ourselves to win share in new markets, including opportunities in mRNA, cell and gene therapy, biosimilars, and the mAbs market. Our customers are also optimistic and we believe that the level of investment in drug development and scale-out is high. I spent a significant amount of time in Q4 and here again in Q1 visiting accounts. Our customers are scaling, they're investing on multiple fronts, and this is confirming the overall robustness of the markets... As we look ahead, we expect our base business to deliver organic growth in the range of 12% to 16% in 2023, coming off 39% base organic business growth in 2022. As we move through 2023, our strategic priorities will center on the following. Launching new products with a focus on advanced analytics systems and filtration, completing the build-out of our assembly center in Waterford and our application center in Waltham, making further inroads into the mRNA and cell and gene therapy markets, and finally, strategically managing key accounts so we can accelerate the adoption of our technologies, especially in large pharma. We continue to be well-positioned in bioprocessing and expect a turnaround as we progress through the second half of 2023 with a much more robust year for our industry in 2024. I believe we have the right mix of differentiated products, the right business plan, and team in place to continue to win share and disrupt this industry. Now I'd like to turn the call over to Jon for a report on our financial performance.

Thank you, Tony, and good day, everyone. Today, we are reporting our financial results for the fourth quarter of 2022 as well as providing our financial guidance for the year 2023. Unless otherwise mentioned, all financial measures discussed reflect adjusted non-GAAP measures. As shared in our press release this morning, we delivered revenue of $186.8 million in the quarter and $801.5 million for the full year. The highlight once again was the continued strength of our base business, which grew by 35% organically in the fourth quarter and 39% organically for the full year. Within our base business, we saw continued strength in our gene and cell therapy business, which grew at 36% and 52% as reported for the fourth quarter and full year respectively, and represented between 14% and 15% of total revenue for the year... ...For the total business in the fourth quarter, organic revenue growth was 4% and constant currency growth was 5% while overall reported revenue was flat year-over-year. For the full year, organic growth was 22%, constant currency growth was 25%, and reported revenue growth was 20%. FX headwinds for the quarter and full year were slightly greater than $9 million and $33 million, respectively, reflecting a 5-point headwind on reported growth for both periods. We expect these headwinds to remain through the first half of 2023, and overall, we expect foreign exchange to be a 1-point headwind for the full year. Inorganic M&A had approximately 1 point of positive impact on reported growth for the fourth quarter and nearly 3 points of favorable impact for the full year. Digging deeper into our overall revenue performance, our 35% base business organic growth in the fourth quarter was essentially offset by reductions in COVID-related revenue of $38 million. For the full year period, the overall increase in base revenue of greater than $160 million more than offset the decline in COVID-related revenues of $49 million. As it relates to 2022 regional revenue growth, we had a strong overall growth year in Asia, North America, and Europe. For the full year, overall increases from Asia/rest of the world increased by 29%, North America grew by 25%, and Europe grew by 10% despite the significant COVID headwind in the region... ...Regarding overall revenue distribution by region for the full year of 2022, Asia represented 20%, Europe represented 37%, and North America represented 43% of our global business. Now moving down our income statement, adjusted gross profit in the fourth quarter of 2022 was $96.1 million, a reduction of $9.2 million or 9% compared to the same period in 2021. Adjusted gross margin of 51.5% in the quarter was down from 56.4% in the prior year fourth quarter. Gross profit and gross margin levels were impacted by multiple factors in the quarter, including lighter volume leverage on our factories, weakening foreign currencies, less favorable product mix, material cost inflation, and the impact of facilities and depreciation related to capacity expansions going live during the quarter. Of these multiple factors, the largest driver of the decline in gross margins was the change in product mix where we saw a significant drop-off in hollow fiber filtration revenue directly related to COVID demand and a decrease in Protein A ligand sales due to lower Cytiva demand. Revenue declines in these product lines were partially offset by revenue gains from lower-margin product lines like OPUS pre-packed columns, fluid management assemblies, and systems... ...Adjusted gross profit for the full year 2022 finished at $456.9 million, an increase of $62.1 million or 16%, and adjusted gross margin was 57%, representing a decrease of 190 basis points year-over-year. The factors that highlighted the drivers for the fourth quarter performance are consistent for the full year. Now transitioning down the P&L to adjusted operating expenses. Adjusted research and development expenses for the fourth quarter and full year 2022 were 5.9% and 5.4% of total revenue, respectively. In 2022, we launched 10 new products and we continue to differentiate our products with best-in-class technologies across our franchises. Adjusted SG&A expenses for the fourth quarter and full year 2022 were 23.5% and 22.6% of total revenue, respectively, compared to the 22% level in the same 2021 periods. Year-over-year dollar increases are related to continued investments in our commercial team and expenses being realized from facilities and depreciation as our capacity expansions are going live to support our business for long-term growth... ...Now moving to adjusted earnings and EPS. Adjusted operating income for the fourth quarter of 2022 was $41.1 million compared to $55.9 million in the fourth quarter of 2021. And adjusted operating margin in the fourth quarter of 2022 was 22% compared to 30% in the fourth quarter of 2021. The reduced levels of operating income and margin are also related to the aforementioned product mix and inflation in the quarter. Adjusted operating income for the full year of 2022 was $232.2 million, an increase of $17 million or 8% compared to 2021. Adjusted operating margin for the full year 2022 finished at 29% compared to 32.1% in 2021. Factors highlighted in our gross margin commentary were partially offset by lighter operating expenses as we finished the year. Here in 2023, we plan to continue to invest in important product development programs and in commercial resources to support revenue growth, which has been paramount to our success over the last several years. At the same time, we are actively managing our operating expenses so that we can continue to deliver improving financial returns with operating margin gains as we progress through the year... ...Fourth quarter of 2022 adjusted net income was $39.1 million, a decrease of $7.8 million or 17% compared to the 2021 quarter. Adjusted net income for the full year 2022 was $188.6 million, an increase of $13.3 million or 8% compared to 2021. Adjusted EPS for the fourth quarter of 2022 was $0.68 per fully diluted share, a decrease of $0.13 or 16% compared to $0.81 in the 2021 period. Adjusted fully diluted EPS for the full year of 2022 finished at $3.28, an increase of $0.22 or 7% compared to $3.06 for the 2021 full-year period. As it relates to capital expenditures, the company invested $88 million in 2022, most significantly related to capacity expansion projects to provide business continuity and address our expectations for increasing demand. More specifically, 2022 included expansions of our hollow fiber, flat sheet, and systems manufacturing sites in Rancho, California and Marlborough, Massachusetts. We also completed the build-out and validation of our fluid management assembly facility in Hopkinton, Massachusetts. Other important capacity investments were related to our proteins business and continued investments in our SAP platform. Our cash and cash equivalents and short-term investments, which are GAAP metrics, totaled $623.8 million at December 31, 2022... We'll now transition to our 2023 full-year guidance. Our GAAP to non-GAAP reconciliations for our 2023 financial guidance are included in the reconciliation tables in today's earnings press release. As previously mentioned, unless otherwise noted, all 2023 financial guidance discussed will be non-GAAP. Please also keep in mind that our 2023 guidance may be impacted by fluctuations in foreign exchange rates beyond our current projection of a 1% headwind on full-year sales and does not include the potential impact of any future acquisitions that the company may pursue. We are setting our 2023 full-year revenue guidance, a GAAP metric, at $760 million to $800 million, representing reported growth in the range of minus 5% to flat and organic growth of minus 4% to plus 1%. This revenue guidance includes base business revenue of $730 million to $760 million, growing at 11% to 15% as reported and 12% to 16% organically. Our guidance also includes COVID-related revenues of $30 million to $40 million, a year-over-year reduction of $106 million at midpoint... ...We are guiding our 2023 adjusted gross margin to the range of 52.5% to 53.5%, showing improvement from the Q4 2022 low of 51.5% and down 400 basis points at midpoint versus 2022. The gross margin headwinds that we experienced in Q4 will continue to impact us here in 2023. We have optimized our manufacturing expenses, which we expect will offset approximately 50% or 150 basis points of the product mix implications, leaving facility and depreciation costs as the major headwinds on margins in 2023 at approximately 250 basis points. We expect margins to improve with higher volumes as we move through the second half of 2023, and we expect to deliver further margin expansion of 100 to 200 basis points in 2024. We are setting adjusted operating income guidance in the range of $176 million to $182 million. We are guiding adjusted operating margins in the range of 22.5% to 23.5% of sales. We expect the impact of product mix, material cost inflation, and facilities and depreciation to drive an approximate 600 basis point decline versus 2022. Optimization of manufacturing and operating expenses will offset approximately 25% of the product mix implications, leaving facility and depreciation costs as a significant headwind on operating margin in 2023 at approximately 300 basis points. Adjusted other income is expected to be $10 million of income for the year, and we expect 2023 adjusted income tax to be approximately 20% of adjusted pre-tax income. We are guiding adjusted net income to the range of $149 million to $154 million, with adjusted EPS guidance in the range of $2.61 to $2.69 per fully diluted share. Our adjusted EPS guidance assumes 57.2 million weighted average fully diluted shares outstanding at year-end 2023. Adjusted EBITDA is expected in the range of $213 million to $219 million, with depreciation and intangible amortization expenses expected to be approximately $36 million and $29.4 million, respectively. Adjusted EBITDA margins are expected to continue to be strong, and we are guiding to a range of 27% to 28% for the year. Now shifting to capital expenditure plans, where we expect to spend $60 million in 2023 with a focus on four primary expansion projects, which Tony covered earlier. We expect year-end cash and cash equivalents, a GAAP metric, to be in the range of $670 million to $680 million, with our CapEx investments again being funded by cash generation from our operations. This completes our financial report and guidance update, and I will now turn the call back to the operator to open the lines for questions.

We will now begin the question-and-answer session. The first question will come from Jacob Johnson with Stephens. Please go ahead.

Hi. Good morning. Maybe, Tony, just to start, on the third quarter call last year, you talked about 16% to 20% base business growth. You're guiding to 12% to 16% this morning. Has anything kind of changed in terms of the demand you're seeing or the end markets, or is this just building in some conservatism, and perhaps you could still end the year closer to that 16% to 20%?

Yes. I would say that since our Q3 earnings call and the beginning of the year, things have shifted a bit. The most significant change has been in our chromatography business. We had anticipated much higher growth from chromatography in 2023 due to resin availability from the primary players in our industry. However, that expectation weakened in Q1 and has continued to decline over the past six to eight weeks, which has really affected our performance in the first half of the year, as it's beyond our control. We have had discussions and know that capacity is increasing, but customers need to adapt to manufacturing from the new facilities. This is probably the main factor contributing to the slower progress on resin availability in the first half. If I had to highlight one key difference between our outlook in November and January compared to today, that would be it.

Okay. Thanks for that, Tony. And then just maybe on the process analytics side, I think that was a key focus at your Investor Day. It seems integral to the system strategy you have. And it seems like that's a real opportunity for you all over the next five years, but it does seem like it's a bit softer this quarter. So could you maybe kind of square the near-term performance there versus the long-term opportunity?

I really appreciate this business. When we analyze the range of opportunities and our activity in the market, it's quite substantial. The demand for at-line and in-line technologies is currently at an all-time high. However, I believe there is some caution among customers regarding their spending and the approval processes for capital equipment purchases. We're excited about the RPM system we launched in Q4, and receiving orders in December was encouraging. We are conducting many demonstrations of the technology and view it as a foundational element that enables our customers to progress from the benchtop KR2i to our ARTeSYN kit, leveraging our analytics to stand out from other market products. While last year saw a decline in overall growth, I think this trend aligns with many companies offering analytical and quality control products. Additionally, I want to highlight that our analytics business is characterized by orders that come in and are shipped within the same quarter, unlike other divisions where orders might be placed several months in advance.

Got it. Thanks for taking the questions, Tony.

Thanks, Jacob.

The next question will come from Dan Arias with Stifel. Please go ahead.

Good morning, guys. Thanks for the questions. Tony, I know parsing through the quarters on an outlook is difficult. But just on the first half of the year versus the second half of the year split that you see right now for '23, does the base case sort of assume some improvement in Q2 that lends evidence to the idea that the destocking phenomenon is subsiding and that resin availability is maybe getting better again, or really should we just be thinking about Q1 and Q2 similar with Q3 being the improvement quarter?

I believe Q3 will show improvement, indicating that the second half of the year will outperform the first half. What I found particularly encouraging is that when we examined our pharma orders in Q4, it was the highest quarter of orders we had throughout 2022, with a book to bill ratio comfortably over 1. This is very promising. Additionally, for Repligen's pharma business, we also surpassed a book to bill ratio of 1 for the year. The challenges we are facing are primarily at the CDMO level. If the CDMOs start to recover, we did see some improvement in Q4, but not enough to confidently predict how that will progress into Q1 and Q2. At this point, I'd say the second half of the year looks stronger than the first half. It's important to note that our COVID revenues will primarily come in Q1, with little revenue expected in Q2 and Q3. Therefore, I anticipate that our base business will begin to see an uptick in orders by Q2, but in terms of revenue, the second half of the year will be more significant.

Yes, okay. And then, Jon, maybe on the op margin, 22.5 to 23.5, it feels like in order to land at the midpoint of '23, you should be or we should be thinking about a step down from Q4 to Q1 rather than being flattish as a jumping-off point for the year, which I think is maybe the way that you were describing things at the end of the year. Is that right? And then you called out mix as a factor. It also feels like it's a little bit of a deviation just given that it felt like more of a volume thing and a leverage thing at the end of the year rather than a mix phenomenon. So can you just add some color to the moving pieces at the margin line and then the flexibility that you might or might not have on cost and spending? Thanks so much.

Sure. I believe the first part of your question was about operating margins and how we are transitioning from 2022 to 2023. We expect to start at the lower end or slightly below guidance in the first quarter, then improve as the year progresses and ideally reach the midpoint of our range at 53%. We're aiming for a margin between 52.5% and 53.5%. Regarding gross margin, there are two main themes to discuss. The first significant factor in the fourth quarter was an increase in material costs as a percentage of overall revenue, which I will elaborate on. Additionally, we faced higher facilities and depreciation costs related to our capacity expansions and business continuity efforts. To provide a comparison, in the third quarter of 2022, we finished at 57%, while the fourth quarter dropped to around 51.5%, which is a decline of approximately 550 basis points. Breaking this down, material cost inflation from suppliers contributed about 150 basis points to the market decline from Q3 to Q4. Furthermore, product mix and volume accounted for an additional decline of about 300 basis points. These two factors led to a total of about 450 basis points affecting material costs. Lastly, the decline related to facilities and depreciation costs added approximately 100 basis points to the fourth quarter decline.

Okay. Thanks very much, Jon.

The next question will come from Puneet Souda with SVB Securities. Please go ahead.

Hi, Tony and Jon. Thanks for taking the questions. So first one, just given on the top line, Jon, wondering if you can provide us what's the base business growth for the first quarter should be. I'm not sure if I heard that. And then do you still stand by your long-term base business ex-COVID growth of 20% and the 2027-'28 revenue estimate of $2 billion?

Yes. I can address that, Puneet. In the long term, we are very confident in our company and our products, as well as our competitive position in the market. This year, 2023, presents unique challenges that everyone in our industry needs to navigate. While we do not provide specific guidance for Q1 regarding base business growth, we anticipate an organic growth rate of 12% to 16% for the year. As the year progresses, I'll have more to say about Q1 and the first half compared to the second half. It's important to remember that despite finishing 2022, we achieved a remarkable 39% organic growth in our base business, significantly outpacing the industry's growth. This reflects substantial momentum that we have cultivated over the years. However, we acknowledge that 2023 will be a challenging year, and we project to remain within that 12% to 16% growth range. The chromatography sector poses particular challenges, but in the medium to long term, we are enthusiastic about our products and our market position. We see no reason why we cannot achieve growth of over 20% in the future, with the exception of the challenges we are currently facing in 2023.

Got it. Okay, that's helpful. And then on the gross margin side, Jon, was just wondering if there was any pricing pressure that you are accounting for? And Tony, maybe just on product obsolescence, product expiration, any write-downs that CDMOs might be taking there? Could you elaborate a bit more on that? And if I could just squeeze in on PAT question. There was a large acquisition in this space for PAT, at least. So wondering how DRS Daylight Solutions is positioned versus the sort of light scattering capabilities that were acquired recently by a competitor? Thank you.

Yes. I'll begin with the acquisition of Wyatt by Waters. It's a fantastic company with impressive technology. You're likely familiar with them. Laser light scattering is a key technology in our industry. When I consider what we're doing with our C Technologies and DRS, we are in a strong position regarding in-line technologies. We can integrate FlowVPX into a manufacturing process. We will also implement the DRS Daylight technology in line. Our strategy focuses on achieving in-line monitoring and real-time monitoring rather than just quality control testing or offline monitoring. This reflects our perspective; we are primarily an in-line company.

Just the pricing in obsolescence. Thank you.

Yes, I was going to answer it. So obsolescence, we're not seeing that as an issue, right? And I think it's really the inventory buildup at our customer level that just has to work through it. And then Jon can answer the question on margin.

Could you repeat the question on margin? Just want to make sure I get it right.

Yes, Jon, just pricing, are you seeing a decline in pricing or pricing impact? And what's the pricing assumptions that you have for '23? Just wondering if there's an impact from that in gross margin? Thank you.

Yes. We have not been seeing pricing pushback of significance. We did finish '22 with just above 5% price achievement as we had indicated we were gunning toward. So that wasn't a major issue. For 2023, we definitely have raised prices again, working with our customers with the intent to cover inflation, and we expect for 2023 that we should be able to get 4% to 5% price achievement this year.

Thanks, guys.

Thanks, Puneet.

The next question will come from Marta Nazarovets with JPM Chase. Please go ahead.

Hi, everyone. Good morning. Thank you for the questions. Let's begin with cell and gene therapy. It looks like we have over 20 accounts now generating $1 million. The order book appears to be solid. Could you discuss how we should consider the growth expectations for 2023? It seems a bit lower than the current order book, and while I understand there are challenging comparisons, I would appreciate further insights on this.

Yes. So cell and gene therapy, a great year last year, no doubt about it. But like every other business we have, right, we saw orders slowdown in the second half of the year. I think what people forget is that 50% of our cell and gene therapy revenue comes from CDMOs. And so we're telling and calling out that CDMO order book has been really light, and it's got to pick up. So when you think about our cell and gene therapy growth and any upside in cell and gene therapy, it's going to come from the CDMOs coming back to where they were in the early part of 2022.

Great. Thanks. And then maybe just new product introductions and how to think about the cadence for this year? It's obviously 10 this year. It was in the 9 to 12. It would be great to kind of dig in there and understand a little bit better kind of what you're hoping for?

Yes. One of our main focuses over the past three years has been to enhance the frequency of new product launches. As I mentioned earlier, we had a strong year last year, with 7% of our revenue coming from products released in 2021 and 2022. For this year, when we include the products expected to launch, the total from 2021, 2022, and 2023 will be around 14%. This aligns perfectly with our goals. We are investing approximately 5% to 5.5% in R&D, and the market response to our new products indicates that we are successfully covering our R&D costs. We are very pleased with the progress of our R&D initiatives, the strength of our product portfolio, and it reflects the characteristics you would expect from an innovative company like Repligen, where our R&D efforts are driving growth. In response to concerns about our long-term growth, I believe that the additional 5% to 7% growth will stem from our R&D activities. This is why it's crucial for us to maintain our R&D investment even in a challenging year like 2023, as these products will be the building blocks for the next five years and beyond.

Great. Thanks, guys.

The next question will come from Matt Larew with William Blair. Please go ahead.

Hi. Good morning. The most significant change in revenue, aside from COVID, is in chromatography, which dropped from 45% in 2022 to 10% in 2023. Could you explain what growth would look like if resin availability weren't an issue? Specifically, what does the demand appear to be? Also, at this point, is the challenge related to customers needing to accept the new products, or is it primarily due to the ongoing issue with the availability of raw materials, especially resin, before customers can accept the products?

Sure. Here's a brief overview of how we handle our chromatography business in relation to past comparisons. Five years ago, Repligen sourced resins to fill our chromatography columns, directly interacting with resin suppliers. However, in 2018-2019, we made a strategic shift away from Repligen sourcing to having customers send us the resin or arranging for it to be drop-shipped from suppliers. As a result, our engagement is now primarily with our customers rather than resin suppliers. Currently, customers are experiencing delays in receiving resins. We have a substantial order backlog, and if resin supply were not an issue, we believe our growth would be close to 25%. However, with resin supply constraints currently limiting our growth to about 10%, it is disappointing and beyond our control. We are aware that additional capacity is becoming available, and we have discussed this with various suppliers. However, there is a necessary process for customers to qualify new manufacturing locations before they can be utilized. We expect improvements as the year progresses, but the current growth is significantly lower than we had anticipated earlier this year.

Okay, that's helpful. Jon, regarding the facilities and depreciation challenges, as we look at the pacing for this year and into 2024, we know that 2021 and 2022 were heavy in capital expenditures. You mentioned 69% for 2024, and I assume that will start to ease in the latter half of the year. As we work on improving our gross margins, could you provide some insights on the first half versus the second half, keeping in mind your comments about operating margins hitting a low in the first quarter and then improving? Any initial insight, especially concerning depreciation, would be appreciated.

Yes, the $60 million of CapEx we mentioned is for 2023, not 2024. Regarding the facilities and depreciation costs, I would suggest starting at the lower end of the overall gross margin at the beginning of the year and then increasing it as the year progresses. That would be my current recommendation.

But I think the most important piece on depreciation and facility cost is that it's a fixed cost, right? And so as our volumes increase, right, margins are going to improve. So we've made this big investment, as everybody knows, over the last three years to build out capacity to give us dual manufacturing capacity and business continuity plans. So this is going to pay off as we go through the next few years, and margins will improve.

And I think even the second half of 2023 should improve from the first half of 2023. So that's kind of the scaling that we talked about and the layering in; lighter first half, better second half.

Okay, great. Thanks for the questions.

The next question will come from Brandon Couillard with Jefferies. Please go ahead.

Hi. Thanks. Good morning. Jon, on the mix dynamics, could you just stack rank the segments from highest gross margin to lowest gross margin? Aside from the COVID runoff, what exactly are the mix in '23, where those come from?

In 2023? So the declining revenues from much of the COVID-related volume was high margin filtration, right? So it's hollow fiber, it's flat sheet filtration, which are really high margin products for us, the consumable components. We don't give specific margins for every product, Brandon, but I can tell you those are very high contribution margin products. And they're coming in being replaced with OPUS, being replaced with systems and fluid management products that are coming in at a lower pace. And we think as we've got facilities built out, as Tony and I talked about earlier, as we start to pump volume through our facilities, so those costs will get spread out better and we'll gain margin traction over time. But I can tell you the OPUS margins, you've known that for a long time, are a bit lower than the others and then systems and fluid management are a bit lower clearly than the filtration stuff, the specific filters and consumables.

Got it. And then Tony, how are you feeling about the M&A pipeline? Obviously, company valuations reset at all and the portfolio.

Yes, you broke up a little bit, but I got the gist of the question. I would say M&A pipeline is pretty similar in 2023 as we saw in 2022. We continue to be active in the sense that we have lots of different companies that we're talking to. I think our pace of M&A, Brandon, is not going to be too dissimilar to what we've seen over the last four or five years. I think we had a big pickup in 2020-2021 during COVID where we were systematically building out our fluid management business. But I think a deal a year pace is probably a good assumption. And to your second part of that question, I do think that the multiples have come down a little bit, but it's all in the eye of the beholder.

The next question will come from Matt Hewitt with Craig-Hallum. Please go ahead.

Good morning. Thanks for taking the questions. Maybe for the first one, I'm trying to piece two different comments that you made together. First, you were talking a little bit about the resin availability and some of the inventory issues, and then also the fact that obviously those resins are acquired by your customers and then shipped to you. Does that create or lengthen the inventory channel issues that you've kind of been facing over the past couple of quarters where the customers are having to churn through inventory? Does this kind of exacerbate that problem or is it a completely different issue?

I think it's a different issue, Matt. I think if I looked at the last two or three years, and I'm certain that the major resin suppliers would give you this exact same view, I think the demand is exceptionally high. I think customers are placing orders six to nine months out. That has not come in, whereas the rest of the industry has, as capacity has come online. So that's the one area in our industry where it really hasn't. It's come down a little bit in terms of lead times, but not enough to change the order pattern or the length of time it takes for those resins to get, a, procured and then delivered, whether it's directly to the customer or a drop ship to us.

Got it. And then obviously you built out a lot of capacity the last couple of years. As far as hiring plans are concerned, are you feeling that you're in a pretty good place from a headcount standpoint or do you anticipate needing to fill some more roles given the demand that you're anticipating in the back half of the year and into '24? Thank you.

Yes. I think that regarding headcount, we have been careful about our hiring decisions, even during COVID. We focused on being strategic about where and what we hired. As we moved through Q4 and into Q1, we continued to optimize our workforce. We are assessing where the demand lies and determining the headcount needed to meet our forecasts for the year. A lot of optimization has taken place over the past few months.

Understood. Thank you.

Thanks, Matt.

The next question will come from Conor McNamara with RBC Capital Markets. Please go ahead.

Hi, guys. Thanks for taking the question. I appreciate it. If you just look at the guidance that you're giving, it's about a 4% cut relative to what you were talking about in Q3. And by my math, that's about $25 million in sales. So is there any way to break that out? How much of that is the inventory destock at the customer level versus the resin impact versus anything else?

Yes, there's a point from foreign exchange. Depending on how we calculate it, the difference is between three and four points compared to what we discussed in January. Most of that change is coming from chromatography, while the rest is spread across the other business segments. There's no single business that is significantly lower, perhaps one to two percent below our previous expectations. The primary change from January to now is related to chromatography.

Got it. Thank you. And then just longer-term margins, if you get towards that '27-'28 targets of $2 billion, what can gross margins go longer term? Can you get back to the high 50s or should we be thinking about longer-term kind of in the mid-50s gross margin range? Thank you.

It is difficult to provide exact predictions on where margins will be in five years. However, due to the investments we've made, particularly in 2021 and 2022, along with some final work in 2023, we believe we have sufficient capacity extending to 2027. We expect margins to increase, with an anticipated addition of 100 to 200 basis points to our gross margin next year. Beyond that, the increase may range from 50 to 100 basis points, although it’s challenging to specify exact figures without knowing the product mix and potential mergers and acquisitions in the coming years. However, we do expect consistent improvement.

Got it. Thanks for that, Tony. I appreciate it.

The next question will come from Justin Bowers with Deutsche Bank. Please go ahead.

Hi. Good morning. It’s Asaf speaking on behalf of Justin. Just two quick questions. So firstly, you mentioned cell and gene therapy business growing significantly in '22, a little slowdown as well and also a 25% step-up in gene therapy during Q4. Which indications in cell and gene therapy are you gaining traction in? And as you look at 2023 and 2024, how are you thinking about the growth rates in these modalities?

Yes. When I mentioned my thoughts on pharma in Q4, it was clear that it positively influenced our gene therapy efforts. The challenge is that half of our cell and gene therapy revenue comes from CDMOs. While we did see some growth in Q4, we need that momentum to continue over the next few quarters. We're projecting a 15% to 20% growth for cell and gene therapy, but the overall market growth could be even higher. This is primarily due to many customers holding inventory, as they're using and developing products through Phases 1 and 2. I believe that, in the long run, cell and gene therapy, including mRNA, is likely to see an average growth of 20% to 30% in the coming years. However, this year is unique because of the destocking at the CDMO level.

Thank you so much for the color. I appreciate it. And just lastly, which areas of material cost inflation were greater than anticipated? And does the guide contemplate inflation at these levels in 2023 or is there like some release at some point in the year?

Yes, it's areas like plastics and stainless steel and a lot of those types of areas where we see the significant inflation. Our guidance contemplates what we believe is going to be the inflation for the '23 period, yes.

All right. Thank you so much.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Tony Hunt for any closing remarks. Please go ahead, sir.

Great. Thank you, everybody. I appreciate everybody joining today. Obviously, we've covered a lot. Obviously, 2022 was a stellar year. We got some headwinds as we move through the first half of this year, but I think we're very optimistic about the second half of the year overall and look forward to getting back on the call in a couple of months and bringing you up to speed on where we are in Q1. So thanks everybody for joining.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.