Avantor Inc (AVTR) 2018 Q3 法說會逐字稿

Welcome to the Avantor Third Quarter 2018 Conference Call.

(Operator Instructions)

I would now like to hand the call over to James Kalinovich.

Welcome to Avantor's Third Quarter 2018 Financial Conference Call. I'm James Kalinovich, Treasurer, and I am joined by Michael Stubblefield, our CEO, and Greg Cowan, our CFO.

Today, Michael will lead our discussion by providing an overview of our financial and business performance; Greg will then give more detail on our third quarter financial results and the status of our integration efforts as well as the progress we are making with revenue and cost synergies; following final commentary from Michael, we have [John Tunuver] from Goldman Sachs joining us to announce a repricing of our term loans; we will then open the lines for Q&A.

Our third quarter 2018 consolidated financial statements and our slide deck accompanying this call are posted on the Intralinks and Debt Doman sites.

I would like to note that we will be making some statements during the call that are 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 several risks and uncertainties, including those set forth in our offerings circular dated September 22, 2017 and in our SEC filings.

Actual results may differ materially from any forward looking statements that we make today. These forward looking statements speak only as of the date they are made, and we do not assume any obligation to update whether as a result of new information, future events, and developments or otherwise.

In discussing the third quarter and year-to-date results of Avantor, Inc., we will report on a consolidated basis and compare to pro forma combined operating results in 2017.

Now, I will turn the call over to our CEO, Michael.

I am pleased to report that the strong momentum we reported in the first half of 2018 has continued into the third quarter with sales of $1.48 billion, up 8.7% from the prior year period.

Taking into account the impact of currency, organic growth in quarter was 9.6%. Third quarter adjusted EBITDA was $264 million, up 28.1% compared to the prior year. The near double-digit lift in revenue reflects robust volume growth across our core customer segments and product categories.

We saw especially strong growth in our education segment where we benefited from significant new account wins. Revenue growth in biopharma -- our largest customer segment -- continues to be driven by double-digit growth in our bioproduction platform.

As anticipated, execution of our operating plan and synergy program drove a 280 basis point expansion to adjusted EBITDA margin and led to significant cash generation within the quarter. We remain on track to realize approximately $105 million of costs in commercial synergies in 2018.

In a moment, Greg will provide further detail on our financial performance including our cash flow and leverage profile as well as a status update on our integration progress.

Turning to Slide 6, let me give you some color on our third quarter business performance. As I mentioned, we are seeing continued strength in our biopharma segment where sales in the third quarter increased once again by high single-digits. Reflecting the breadth, reach, and strength of our integrated platform, this customer segments, which accounts for roughly half of our total revenue, is seeing strong volume growth across all aspects of our portfolio including lab products, production products, and our services offering.

Our healthcare platform grew at mid single-digits in this quarter, reflecting strength in our clinical lab and hospital accounts.

In education, we saw accelerated growth driven by continued strong funding and new contract wins in the Americas, including the largest purchasing consortium serving the education sector.

Our government platform where we are seeing low single-digit growth is benefiting from our positioning with state government accounts in the Americas but is being somewhat offset by a weaker environment in Europe and Asia.

Our industrial customer segment continues to grow mid single-digits, consistent with historical performance.

Growth in each of our product categories remains robust. In lab products, we are seeing especially strong growth across each of our offerings and are particularly pleased with the double-digit growth of our consumables platform. We continue to benefit from high double-digit growth in Asia as we execute the integration of our legacy business models.

Strong growth of our production products is again being driven by double-digit growth of our bioproduction offering, reflecting the momentum in the end markets and our growing relevance in this space especially with our single-use technologies.

Our services offering continues to exhibit high growth as we extend the value we offer our customers by taking on more of the workflow within their laboratories, especially within biopharma.

Biomaterials continues to perform at record levels as our investment in innovation is driving significant growth in all of our key segments, including aesthetic and reconstructive implants, medical implants, and general healthcare.

Finally, our advanced technology platform targeting the aerospace, defense, and semiconductor industries experienced a modest slowdown as growth in both the Americas and Europe was offset by softness in the Asian electronics space.

Overall, I'm pleased with the accelerated momentum we saw in our third quarter top line performance and the favorable response toward integrative platform that we are seeing from our customers.

With that, I will now turn the call over the Greg, who will provide some additional commentary on our financial performance.

I am on Slide 7 of the earnings deck.

We've reported third quarter revenue of $1.48 billion, up 8.7% compared to the prior year on a consolidated basis and up 9.6% on an organic basis. As Michael mentioned, this performance was a result of continued strong volume performance in all customer segments and virtually all product categories.

Currency effects reduced top line performance by 0.8% as the US dollar strengthened particularly against the euro. Our consolidated gross margin was 32%, up 120 basis points compared to prior year. Efficient pricing, product mix, and value capture achievements drove year-over-year margin expansion.

SG&A expenses were at $344 million in the third quarter, up 11.6% compared to prior year. Adjusted SG&A expenses declined $8 million or 3.6% year-over-year, excluding $30 million in one-time items in Q3 2018 and $33 million in Q3 2017 as well as depreciation and amortization.

This decline in adjusted SG&A expenses more than offsets normal inflationary pressures in the business. I would also note that this 3.6% decline year-over-year accelerates the 1.9% decline year-over-year we experienced in the first half of 2018.

In the third quarter of 2018, adjusted EBITDA was $264 million, and our adjusted EBITDA margin was 17.95%, up about 280 basis points compared to prior year and approximately 100 basis points compared to Q2 2018.

Continued sequential expansion and operating leverage reflects our ongoing value capture initiatives.

Before moving on to the integration progress, I want to confirm that our top line momentum continues into the early stages of Q4 and execution of our synergy programs remains on track.

Slide 8 shows how we are progressing with our synergy realization. As mentioned on our previous conference calls, we have over 200 initiative underway and we continue to make good progress. We expanded our synergy realization by $9 million sequentially in the third quarter and have realized $71 million of costs and commercial synergies on a year-to-date basis, which comprises approximately 70% of 2018 target of $105 million. Importantly, these benefits represent about $131 million on an annualized basis.

At this point in 2018, we are confident we will achieve our budgeted value capture benefit of $105 million, of which approximately 76% is comprised of cost synergies and the residual associated with commercial synergies. The asset run rate associated with this projected achievement will yield $145 million of savings in 2019.

Moving on to cash flows and net leverage, year-to-date 2018 operating cash flows before interest and restructuring payments totaled $524 million. This performance exceeds prior pro forma operating cash flow by $128 million, up 32% on a year-to-date basis, reflecting solid EBITDA growth driven by both organic growth in the business and our value capture achievements.

As we continue to understand the implications of new tax laws together with our 2017 tax refund, we expect cash taxes to be approximately $95 million in 2018. While we will be announcing a repricing of our term loans on this conference call, the benefits from this initiative will not significantly change our 2018 cash interest expectation of $480 million for full-year 2018.

On the investment side, we do not anticipate any acquisitions in 2018, and we expect to invest up to $60 million in CapEx during 2018. Our CapEx spending estimate incorporates maintenance, growth and synergy investments. As of September 30 our liquidity was $642 million, up $96 million or 18% from June 30, 2018.

We continue to believe that we have sufficient liquidity to meet our expected current and future needs. As we look forward, we anticipate utilizing our residual free cash flow to deleverage our balance sheet.

For reference purposes, aggregate debt paydowns through September 30 totaled $95 million on a year-to-date basis. I am pleased to report that of September 30, 2018 our net leverage has decreased to 6.4 times our position of 7.0 times at year end 2017 and 6.7 times at June 30, 2018. Our view on capital deployment remains unchanged as we continue to focus on investing in our ongoing business needs, deleveraging, synergy capture and reducing our debt service costs.

With that, I'll now turn the call over to Michael.

Please turn with me now to slide 10.

With third quarter organic revenue growth of 9.6% we have seen accelerating top line momentum continue through the third quarter. Each of our customer segments remains strong, especially biopharma and education. We are seeing strength across our integrated portfolio, led by double digit growth of our biopharma production and biomaterial platforms. All three regions are performing at or above plan, including Asia, where we are aggressively leveraging our combined footprint to drive outsized growth.

Our integration and synergy program continues to progress well and we remain on track to deliver approximately $105 million of synergies in 2018. With an exit run rate of approximately $145 million, we have generated nearly half of our three year target within the first year of integration. With nearly 30% growth in adjusted EBITDA we're clearly seeing the benefits of our combined business model as we realize the impact of our operating plan and synergy program.

This continued EBITDA expansion drove third quarter leverage of 6.4 times, a decrease of more than a half a term versus year end 2017. We remain focused on our customers and are confident in our ability to deliver our 2018 operating plan.

I want to take this opportunity to thank the entire Avantor team around the world for their exceptional performance in the third quarter.

With that, I will now turn the call over to John Tunuver from Goldman Sachs to discuss the repricing of our term loans.

This is John Tunuver with Goldman Sachs.

On behalf of Avantor, I am pleased to announce a repricing of both the dollar and euro term loans. Avantor's credit profile has materially improved since the initial financings in September 2017. Driven by continued strength in the Company's end markets and on track progress in the integration of VWR, quarterly organic revenue growth has accelerated form 1.8% to 9.6% year-over-year.

LTM pro forma adjusted EBITDA has increased 8.2% to $1.1 billion as of September 30, 2018. On the back of this growth, Avantor has significantly delevered. As of September 30, 2018 net secured leverage and net total leverage have decreased to 4.6 times and 6.4 times respectively. The Company has also made significant progress in the integration of VWR. The Company remains on track with our 2018 target of $105 million of achieved synergies. Finally, recognizing the strong performance and progress of integration efforts, Moody's has removed their negative outlook.

As a result, the Company's corporate rating profile is now B3 stable for Moody's, B stable from S&P and B stable from Fitch. Following this material improvement in its credit profile, Avantor is launching a repricing of both the dollar and euro term loans. Pro forma for the transaction, both net secured and net total leverage will remain unchanged at 4.6 times and 6.4 times respectively. Commitments and consents will be due on Friday November 16 at noon in New York and 5:00 pm in London.

Turning to slide 12. Slide 12 shows the Company's strong operational performance, achievement of synergies and deleveraging since the fourth quarter of 2017. LTM pro forma adjusted EBITDA has increased to $1.1 billion, an 8.2% increase in three quarters. The Company has made significant progress towards synergy targets, having taken actions that drove $131 million in run rate synergies as of the end of the third quarter.

As mentioned earlier, the Company remains on track for their 2018 target of $105 million in achieved synergies and is expected to have run rate synergies of $145 million by year end. Strong pro forma adjusted EBITDA growth has driven rapid deleveraging since the close of the VWR transaction. Net total leverage has fallen from 7 times to 6.4 times and net secured leverage has decreased from 5.1 times to 4.6 times.

Flipping to slide 13, which shows the Company's current capitalization. We are re-pricing both the dollar and euro term loans. Pro forma, there will be no change in leverage profile or maturity of the term loans.

Moving on to the summary term sheet. The Company is looking to re-price its U.S. dollar term loan to LIBOR plus 350, 1% floor at par. And its euro term loan to Euribor plus 375, 0% floor also at par.

For each tranche, that represents a reduction in spread of 50 basis points. In conjunction with the re-pricing, both the dollar and euro tranches will reset to a 101 soft call for six months. There are no other changes contemplated to the terms of the existing term loans.

On slide 15, we've set out the timeline for this re-pricing transaction. Commitments and consents from lenders will be due on Friday, November 16 at noon in New York and 5:00 p.m. in London.

With that, we will now turn the call over to the operator for Q&A.

(Operator Instructions)

Jason Adler with UBS.

The first one is just on the organic growth. Do you have a sense of whether or not the organic growth is being driven by customers ramping up existing programs or new customer wins maybe away from competition?

Yes I would say, first I thank you -- this is Michael -- for the question -- as we look at the progression of the business, we see a mix of both strength of existing accounts and the growth that we're able to realize in the business that we've had historically as well as a significant number of new account wins as we've brought our platforms together.

We're excited about the momentum that we've built through the year here as we've brought these platforms together.

If I can just ask another one quickly, I apologize if I missed this, is there any update to your relationship with Merck?

Yes, we didn't comment on the scripts; you didn't miss anything.

What I would say there is we don't anticipate any meaningful change in the portfolio that we offer moving forward, nor any material changes in the relationships that we have with our core partners.

We happen to think that we have the leading chemicals portfolio and offering in the industry that gives our customers a very, very broad choice, whether that be from key premium branded offerings from some of our core suppliers or from our own stable of products, whether that be the legacy Avantor's premium branded J.T.Baker brand or the VWR brand who has built up a considerable strength and reputation positioning in the market over recent years.

You mentioned using free cash flow to deleverage. How do you think about prioritizing that cash flow in the capital structure?

Well again -- this is Greg Cowan -- from a capital allocation priority process, obviously we'll continue to take care of the business and support our integration efforts and the value capture that we've committed to as our key priorities. As we grow our top line, we will be making normal investments in our working capital as well.

After that it really comes down to continually deleveraging our balance sheet and reducing the cash interest carry costs that we have as our primary priority. It doesn't mean that we don't entertain and look at potential acquisitions, but I would say that we're a couple of years out from those sorts of activities at this point, wanting keep our capital allocation very focused.

(Operator Instructions)

Sanjay Aiyar with Coherence Capital.

If I just look at your revenue performance charts from 2Q and then now 3Q, looks like on a number of different segments, you've actually seen some acceleration in the revenue growth. Can you talk about what's driving that and generally how do we think about what particular leverage you pulling to get that and where it's coming from?

Obviously, we have seen accelerating momentum in the top-line as we have moved throughout the year and through the third quarter. And if you break it down from an end market perspective, I mean all the markets have been very good throughout the year.

But when we look at a couple of key pockets, for example, the education sector, which we're excited about the momentum that are building there, that's in part being driven by continued strong funding, particularly in the Americas, together with some key accounts wins that we've had there. Some nice penetration and execution from the team as they have focused in that sector over the last couple of years.

I referenced in my script, the win at the largest purchasing consortium in that space, which gives us access to some large programs. And then you look at other areas like biopharma, for example, where there's a level of funding going into that space and a number of molecules that are under development driving a nice trend from an R&D perspective.

And with the breadth and positioning of our portfolio across the spectrum from supplies into the R&D setting that can then be scaled with those programs as they move into production is a really attractive value proposal for our customers and a great value point for the integration of our platform. We see continued interest, particularly in biopharma, in customers who value what we can do for them at lab scale all the way through production scale.

And then from a perspective of margin growth, can you give us some sense in terms of what your ultimate EBITDA margins would be on a run rate basis once you've integrated the merger, gotten synergies and what timeline we can expect that to happen?

Yes, I mean our expectation is that we will continue to grow our EBITDA margins, and again, that's consistent with prior experience for both companies from a legacy perspective. When we think about the generation of incremental revenue and the gross margins that we now have that can attract to that revenue, we see a fairly significant dropdown in terms of contribution to earnings. And we expect to have enough headroom to be able to grow quite nicely our EBITDA margins over time.

We haven't given precise targets, nor is our policy to provide guidance, so I'll stop short of that, but we see ample room to continue to capture additional EBITDA margin [throw-off] as we move forward.

And then from a perspective of Asia, specifically China, any tariffs, how does that impact your business, and any thoughts on, if it does, how you can mitigate that?

Yes, we're keeping a close eye on that impact, I guess, from a couple of areas. One, we do source certain materials coming out of China to support our business in both Europe and the U.S. and to the extent that any of those materials are impacted by the tariffs, we do have an ability to pass those on either through a special surcharge or to incorporate it into our pricing.

To date, as we look the implementation of these tariffs, at least along that direction, you're talking single digit, millions of dollar impact in total that for the most part we're able to mitigate.

The other aspect of course is [flowing] goods into our supply chain into that region and we do have a fair bit of flexibility in our supply chain and can source materials into China out of Europe, for example, as necessary to mitigate some of those impacts. As we look at it today, it's not been a meaningful impact on our business and wouldn't expect it to be going forward.

If I look at the chart on page six and then given that we're at mid-November, how do we compare the trend you're seeing thus far fourth quarter to date versus what you see here? Is it a continuation or it is an acceleration from that point? How do we think about it?

Clearly we've seen nice progressive increases in quarter over quarter top-line as we've moved through the first three quarters of the year. The [lean] on October is relatively consistent in market performance. Obviously, there's some puts and takes that aren't unusual for us when we move into the fourth quarter of the year, but I would say October is tracking nicely to our expectations.

Having said that, the year-over-year growth profile for Q4 is not likely to be as high as we've seen, certainly in Q3, as we face very, very difficult costs for both legacy companies when we put them together for Q4 of last year. Both companies had outsized growth in the fourth quarter, so a little bit more normalization, but certainly our expectations are tracking right to where we envision when we put our budget together at the beginning of the year.

Liz Shortsleeve with Wellington Management.

I just wanted to focus on slide nine, which has the cash flow profile. I see you have some commentary at the bottom, but just wondering the outlook for some of the line items within there, like restructuring, working capital and how those might fare kind of going forward on a run rate basis?

Sure, this is James here.

If you look down our numbers, obviously, you'll come with your adjusted EBITDA forecast. Working capital, typically in the fourth quarter we have a positive flow of cash flows as the seasonality of sales drops in December and as we collect our receivables. We would expect that to still be a negative for the year, but it's going to drop down, could be a $25 million to $50 million swing.

Cash taxes, we've identified already about 95 for the full year. Other assets, other liabilities, probably be about stable with MIP still generating that negative 15 that we had year-to-date would probably drop down to around $5 million negative because it usually balanced out to zero for a full year basis.

Restructuring and integration, we expect to spend another $15 million or so. Interest, you guys can calculate the interest, [still being paid]. And then, with CapEx, as we mentioned, another $30 million or so in CapEx I think for the rest of the year.

And then maybe just on the restructuring, I know you're not giving guidance into '19, but I'm just trying to think about how that line item might trend over time? I know you still have a lot more kind of synergy capture to go on into next year.

The $92 million you see spent year-to-date does include payments of activity from the transaction date of about $30 million or so. Pure restructuring of current programs was about $60 million spent so far.

And that would maybe take us to around $75 million or so for the full year and I think we're still on target for our initial expectations, although things have been pushed out a little bit. I would expect that the pace would be lower next year because we did have quite a bit of upfront severance and type activity earlier in the year.

And just remind me, the full cash costs associated with achieving the synergies as you outlined originally?

Let me chase that down here first. I'm sorry.

[One hundred fifteen] million in the queue.

In the queue. We do have it in the queue -- is it footnote number eight?

I believe it --

Yes, this is Greg Cowan, I'll handle that.

We have an expectation of spending up to about $250 million collectively to secure our plus $300 million of synergy over a three year period. A hundred million or so of that will be associated with incremental capital activity and the primary drivers of that would be to support some of our IT integration efforts, which are, in fact, relatively capital intensive, as well as some of the footprint optimization and condensing of our footprint that we will secure over the next couple of years.

The residual generally associated with the types of activities James was referring to, restructuring, severance related, kind of think of that as the exit costs associated with headcount and some of our recent commitments.

I'm showing no further questions at this time. I would now like to turn the call back to Mr. Michael Stubblefield, Chief Executive Officer, for closing remarks.

Thank you, all, for participating in our call today. We certainly appreciate your continued interest in our business and for your support of the repricing of our term loans. As you can clearly see from our performance, our business is strong and we're certainly optimistic about our future and the finish to 2018.

We look forward to updating you on our fourth quarter and full-year performance early in the new year. In the meantime, thank you again for joining our call and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect.