Avantor - Q2 2023

Transcript

Operator (participant)

Good morning. My name is Emily, and I'll be your conference operator today. At this time, I would like to welcome everyone to Avantor's 2023 second quarter earnings results conference call. After the prepared remarks, there will be the opportunity for any questions, which you can ask by pressing star, followed by the number one on your telephone keypads. I will now turn the call over to Christina Jones, Vice President, Investor Relations. Mrs. Jones, you may begin the conference.

Christina Jones (VP of Investor Relations)

Good morning. Thank you for joining us. Our speakers today are Michael Stubblefield, President and Chief Executive Officer, and Thomas Szlosek, Executive Vice President and Chief Financial Officer. The press release and a presentation accompanying this call are available on our Investor Relations website at ir.avantorsciences.com. A replay of this webcast will also be made available on our website after the call. Following our prepared remarks, we will open the line for questions. During this call, we will be making some forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings. Actual results might differ materially from any forward-looking statements that we make today.

These forward-looking statements speak only as of the date that they are made. We do not assume any obligation to update these forward-looking statements as a result of new information, future events, or other developments. This call will include a discussion of non-GAAP measures. A reconciliation of these non-GAAP measures can be found in the supplemental disclosure package on our investor relations website. With that, I will now turn the call over to Michael.

Michael Stubblefield (President and CEO)

Thank you, CJ, and good morning, everyone. I appreciate you joining us today. I'm starting on slide three. Our second quarter core organic revenue declined 6.5%. Relative to the first quarter, market trends weakened sequentially, particularly in Biopharma, where mid to large pharma customers moderated their spend and continued to reduce inventory, and ongoing funding constraints for small biotech persisted. Sales in our Advanced Technologies & Applied Materials end market were impacted by sharp declines in sales of formulated solutions to semiconductor customers. We also experienced sequential weakness in sales of equipment and instrumentation associated with tighter capital budgets across all end markets. The sustained momentum in our biomaterials and education end markets partially offset these declines, and we are encouraged by the double-digit growth in our medical-grade silicone platform, as well as continued mid-single-digit growth in Education & Government.

We continue to leverage the Avantor Business System to drive cost savings and enhance operational rigor and efficiency. These productivity efforts and cost containment measures helped mitigate the soft demand environment and enabled us to deliver solid bottom-line results, including 19.7% adjusted EBITDA margin and $0.28 of adjusted EPS. We also have strong free cash flow momentum and generated approximately 85% free cash flow conversion to adjusted net income in the first half and paid down over $400 million of debt in the same period. While current market conditions are negatively impacting the entire industry, we are confident in our platform, market position, and long-term growth outlook, and the resilience of our end markets.

We are doubling down on our actions to accelerate our growth strategy and control costs to help offset industry headwinds and ensure that we are positioned to capitalize when market conditions improve. First, we have taken steps to align our organization and key leadership roles to deliver incremental growth. We have added leaders with expertise in high-growth segments and welcome new leaders with a proven track record in driving performance. A few examples include: strengthening business leadership for our proprietary research and materials businesses under Randy Stone, including adding dedicated leadership for our self-manufactured chemicals business and augmenting Ritter leadership to drive revenue synergies and product line expansion. Establishing dedicated strategy leaders under Kitty Sahin's leadership, who partner with business leaders to identify and capture high-growth opportunities.

Adding product management leadership for bioprocessing, fluid handling, and lab digital services, and realigning our regional commercial teams to enable greater focus on customer needs. These efforts are generating results. In the second quarter, in addition to delivering double-digit Education & Government growth in the Americas, our strengthened commercial teams extended multi-year contracts with several renowned institutions and consortiums in the education sector, including the E&I Cooperative Services, which services over 5,000 educational institutions and gives us broad access to the academic community. Second, we are accelerating new product introductions for both third-party and proprietary offerings and investing in Avantor's R&D to support customer needs.

For example, in the second quarter, we launched integrated pressure sensors for our Masterflex MasterSense pumps, novel volume sampling systems to support cell and gene therapy workflows, cryogenic storage vials to support long-term storage of critical biological samples, and introduced a new robotics tip line, the J.T.Baker HT 2. We significantly accelerated new product introductions from our supplier partners during the first two quarters, including onboarding several innovative suppliers to bring thousands of new fine chemical and antibody offerings to our customers, as well as introducing new microplate instrumentation and biological sample storage solutions. We announced plans for a significant expansion of our flagship R&D center in Bridgewater, New Jersey, planned for August 2024. Third, we are well underway with our digital transformation, including enhancing our e-commerce platform and improving campaign execution and commercial activation processes.

We will begin introducing our new online buying experience through a phased rollout across geographic markets, starting this autumn. At the same time, we are simplifying and streamlining lab inventory and replenishment processes for our customers by integrating leading electronic lab notebook and smart shelf platforms with our upgraded Inventory Manager Enterprise system. We've increased web traffic through a variety of digital tactics, accelerated deployment of new product and application-focused email campaigns, and enhanced some of our trigger or action-based campaign programs. We are seeing higher campaign conversion rates as a result of these initiatives. Additionally, we've activated commercial process enhancements that are improving effectiveness in our lead to order conversion rates. These tactics complement ongoing content upgrades and search engine optimization enhancements across our digital channels. We've also intensified our focus on operational excellence and productivity to control costs, as was evident in our second quarter results.

Some examples of these efforts include: rationalizing our manufacturing footprint through closures and downsizings, streamlining our organizational structure and delayering, including simplifying our European organization from three subregions to two in order to reduce cost and complexity and better serve customers. Proactively addressing structural costs and reducing discretionary and indirect spend across our global organization. Executing numerous Kaizen events as part of our Avantor Business System to expedite process improvements and drive stakeholder engagement. Enhancing our supply chain to drive efficiencies, reduce back orders, and improve lead times, including increasing warehouse productivity and efficiency, as well as automation upgrades at our distribution centers in Germany, Sweden, the United Kingdom, and the U.S. Looking ahead, we are revising our full-year 2023 guidance to reflect the more challenging environment the industry faced in the second quarter, which we expect to persist for the remainder of the year.

We're also taking the opportunity to further accelerate our deleveraging and are now targeting adjusted net leverage below 3x. I will walk you through our updated guidance at the end of the presentation. Before I turn it over to Tom to walk you through our second quarter financial results in more detail, I want to remind you of our previously announced CFO transition. As we announced earlier this month, Brent Jones will join Avantor as Executive Vice President and Chief Financial Officer on Monday, August 7. Over a nearly 30-year career, Brent served as CFO for several public and private life science companies and previously as a senior investment banker. He is currently Executive Vice President, Chief Financial Officer, and Chief Operating Officer at LifeScan Global Corporation, a global leader in blood glucose monitoring and digital health technology.

Brent is an innovative thinker and seasoned operator with a strong track record of driving transformation, building teams, and enhancing financial results to increase value for shareholders. He will be an exceptional partner in running the business, and I look forward to working closely with him to advance our growth strategy. As planned, Tom will be leaving Avantor next Friday, August 4, to start a new CFO role outside the life sciences industry. As we welcome Brent to the team, I want to reiterate my appreciation to Tom for his many contributions to Avantor and his support of a seamless transition. With that, let me turn it over to Tom to walk you through our second quarter results.

Thomas Szlosek (EVP and CFO)

Thank you, Michael. Good morning, everyone. Starting from the top of slide five, reported revenue was $1.74 billion for the quarter. Revenue declined 6.5% on a core organic basis, reflecting high single-digit declines in Biopharma and Advanced Technologies & Applied Materials end market, resulting from lower activity levels, constrained spend, and continued inventory destocking by our customers, partially offset by ongoing growth in our healthcare and Education & Government end markets. Adjusted gross profit for the quarter was 33.8%, with a reduction from 2022, driven by lower overall volumes, negative mix impacts of lower bioprocessing and semiconductor revenue, and the roll-off of margin-rich COVID-19 revenues, partially offset by productivity efforts and lower distribution costs. Adjusted EBITDA was approximately $343 million.

Q2 adjusted EBITDA margin of 19.7% was above our guidance, with positive impacts from cost containment, productivity, and lower incentive compensation costs offsetting the negative impact of lower gross profit margins. Adjusted earnings per share came in at $0.28 for the quarter, reflecting the flow-through of adjusted EBITDA performance, interest expense in line with expectations, and a modestly higher tax rate. We also recorded a non-cash impairment expense of approximately $160 million in the second quarter to reflect a reduction in the fair value of the Ritter assets, driven by a persistently high customer inventory in the end market served by Ritter and an overall slowdown in the research spending environment.

The declines in actual and projected income for Ritter have also led to a reduction in current and future tax benefits, leading to a tax rate of 24.2% for the quarter. We remain focused on realizing the long-term growth potential of this business by introducing new products and leveraging our channel to expand Ritter's customer base. Moving to cash flow, we generated $138.1 million in free cash flow in the quarter, which enabled an approximately 85% conversion of adjusted net income in the first half of 2023. This year-over-year improvement in conversion has been primarily driven by sustained improvements in accounts receivable and inventory. Our adjusted net leverage ended the quarter at 3.9x adjusted EBITDA, slightly higher than the first quarter as a result of lower trailing four-quarter adjusted EBITDA, partially offset by ongoing debt paydown.

As Michael mentioned, we have paid down over $400 million of debt year-to-date. Deleveraging is our primary capital allocation priority. Additionally, we strengthened our balance sheet by upsizing our revolver capacity in the quarter from $515 million to $975 million and extended the maturity to 2028. Slide six outlines the components of our second quarter revenue growth. Core organic revenue declined 6.5% in the quarter. COVID-related revenues represented a 2.6% headwind for the quarter, reflecting the expected roll-off of approximately $50 million of COVID-related sales from the second quarter last year, resulting in a 9.1% organic revenue decline.

Foreign exchange translation represented a 0.4% tailwind, driven by a modest appreciation of the euro, resulting in a second quarter reported revenue decline of 8.7%. On to Slide seven. From a regional perspective, the Americas declined 8.8% on a core organic basis, reflecting weaker customer demand in Biopharma and Advanced Technologies & Applied Materials. Biopharma results were pressured by sequential declines in both research and bioproduction, and semiconductor-related sales were down more than 80% as customers continued to reduce finished goods inventory as supply chains normalized post the COVID-19 pandemic. Education & Government grew double digits, with robust funding and focused commercial execution, supporting ongoing momentum and recovery in this end market. Biomaterial sales were also up double digits, driven by strong demand for our custom-formulated silicone solutions in medical implant procedures and healthcare applications.

Our continued investments to debottleneck existing manufacturing assets, paired with operational excellence initiatives, are providing additional capacity to meet strong underlying demand in targeted markets and applications. Europe declined 1.8% on a core organic basis in the quarter, driven by weakness in Biopharma and Education & Government end markets. We experienced softer demand for lab consumables and chemicals, reflecting a weaker demand environment and ongoing destocking. The macroeconomic contraction over the past two quarters in the Eurozone, including the recession in Germany, also put pressure on equipment and instrument sales, which were down high single digits in the quarter compared to high single-digit growth in the first quarter. Biomaterials grew double digits in Europe, and Advanced Technologies & Applied Materials end market continued to grow, demonstrating the benefit of our diversified customer exposure and our increased emphasis on new, high-growth segments.

AMEA declined 8.7% on a core organic basis in the second quarter, driven by declines in formulated solutions for our semiconductor customers, which were down about 70% in the region, and sluggish demand in research settings across all end markets, partially offset by strong core organic revenue growth in bioproduction. Slide eight shows our core organic revenue growth for the quarter by end market and product group. Biopharma, representing almost 55% of our annual revenue, declined high single digits in both research and production. In the research environment, we saw an increasingly conservative approach to customer spending, resulting in project delays, site closures, reductions in headcount, and more aggressive procurement savings targets. This is negatively impacting activity levels in research labs and constraining capital purchases, putting pressure on both consumables and equipment and instrumentation sales.

We are seeing signs of stabilization in the biotech customer base, which remained at Q1 sales levels in the second quarter, while sales to mid-cap and large-cap pharma declined in the quarter. While spending is still constrained, customers are continuing to fund promising science and advance a robust pipeline of clinical research and new molecules. In the production environment, our sales were down high single digits on a core organic basis compared to our expectation of low double single-digit growth as realized in the first quarter. While destocking persisted as anticipated, we also experienced a sequential reduction in demand driven by improved lead times and campaign and project delays. Despite these challenges, we are seeing some encouraging signals. Customer survey data regarding inventory health continues to improve. We've also seen a marked uptick in engineering drawing activity, a critical leading indicator within our single-use platform.

Our focus in cell and gene therapy is also paying dividends, yielding double-digit growth in several critical product lines targeting these workflows. We continue to have high conviction in the fundamental drivers for biopharma. The pace of innovative research and regulatory approvals, including Alzheimer's monoclonal antibodies, GLP-1 treatments, and cell and gene therapies, supports long-term double-digit growth in this industry. Healthcare, which represents approximately 10% of our annual revenue, grew mid-single digits on a core organic basis in the second quarter. Biomaterials performance was up over 30% in the quarter, with double-digit growth across all three regions, driven by continued strength in surgical procedures. Education & Government, representing approximately 10% of our annual revenue, grew mid-single digits on a core organic basis in the second quarter, driven by double-digit growth in the Americas.

We are encouraged by our recent commercial wins and the supportive funding environment and expect continued momentum in this platform. Advanced Technologies & Applied Materials, representing approximately 25% of our annual revenue, declined high single digits on a core organic basis in the second quarter, with solid performance in Europe, offset by declines in the Americas and AMEA, largely attributable to softer demand from semiconductor customers. Semiconductor sales were down over 75% in the quarter, reflecting persistent high levels of finished goods inventory at our largest customers, and represented a roughly 220 basis point headwind to our core organic growth in the quarter. By product group, proprietary materials and consumables offerings were down double digits in the quarter, with destocking and reduced demand for bioproduction products and formulated solutions for semiconductor customers, partially offset by strong biomaterial sales.

Sales of third-party materials and consumables declined mid-single digits, impacted by continued destocking of lab consumables and reduced demand across research settings. Services and specialty procurement, which integrate us directly in our customers' critical operations, grew mid-single digits, while equipment and instrumentation declined mid-single digits, reflecting a more cautious approach to capital spending in the current macro environment. With that, I will now hand the call back to Michael.

Michael Stubblefield (President and CEO)

Thanks, Tom. Turning to slide nine, I'd like to take a moment to walk you through our updated 2023 guidance. As you recall, our prior guidance was predicated on a continuation of first quarter end market dynamics and a modest seasonality pickup in the second half of the year. Given the sequential deterioration experienced in the second quarter, we are updating our guidance to reflect the second quarter revenue miss and the extension of current end market trends through the balance of the year. This results in organic revenue declines of 9%-7% and core organic revenue declines of 6.5%-4.5%. Applying current exchange rates, we estimate reported revenue of $6.89 billion-$7.04 billion.

We expect adjusted EBITDA margin to contract between 200 basis points and 150 basis points, which incorporates our view of lower volume, offset by productivity and discretionary cost control. We expect interest expense of approximately $290 million and a full-year tax rate of 23%, leading to adjusted EPS of $1.04-$1.12. We're also updating our free cash flow range to $675 million to reflect the adjusted EBITDA guidance and a continuation of our free cash flow performance from the first half of the year. Regarding phasing, we expect a relatively consistent performance between Q3 and Q4 for total reported revenue, adjusted EBITDA margin, and adjusted EPS. The primarily short cycle nature of our business model, coupled with a dynamic operating environment, makes forward visibility particularly challenging.

We believe our updated guidance appropriately reflects the realities of the current macro environment and does not contemplate any material change in end market conditions. We recognize that our second quarter results fell short and that we have made a meaningful change to our full year guidance to reflect the current market conditions. We remain confident in the long-term fundamentals of our attractive end markets and of Avantor's proven platform, market position, and targeted growth strategy. We are taking aggressive measures to drive future growth, control costs, and improve productivity to ensure that our organization is well positioned to capture future market opportunities and emerge stronger from the current headwinds facing our industry. We are steadfast in our commitment to our mission of setting science in motion and to our customers, including investing in customer-driven innovation opportunities around the world.

Equally important to helping customers solve scientific challenges is operating sustainably. In the second quarter, we committed to updating our emission reduction goals in line with climate science that will be validated by the Science Based Targets Initiative. As a reminder, in 2020, we set a short-term target of a 15% reduction in greenhouse gas emissions by 2025, and we are on track to beat this timeline. We recently earned a bronze medal for our sustainability rating with EcoVadis. This improved rating is a significant validation of our commitment to sustainability. I'd like to close by thanking our associates for their contributions to our customers and communities, as well as their focus on operational discipline as we navigate these dynamic times. I will now turn it over to the operator to begin the question and answer portion of our call.

Operator (participant)

Thank you. We will now begin the question-and-answer session. If you would like to ask a question today, please do so now by pressing star, followed by one on your telephone keypad. If you change your mind and would like to be removed from the queue, that is star followed by two. When preparing to ask your question, please ensure that your microphone is unmuted locally. Our first question today comes from the line of Tejas Savant with Morgan Stanley. Please go ahead. Your line is now open.

Tejas Savant (Executive Director and Senior Healthcare Equity Analyst)

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

Michael Stubblefield (President and CEO)

Yeah, good morning, Tejas, thanks for the question. Happy to give you some color on, you know, how we have, you know, framed our full-year outlook. As you suggest, we've, we've dropped, at the midpoint, our outlook by about 600 basis points. If you, you know, unpack that, about 100 basis points of that is just a reflection of the Q2 miss getting rolled in.

That leaves you with roughly 500 basis points, which is, you know, probably, the way I think about it is to have that split roughly in equal parts between our expectations for bioproduction as we move through the back half of the year, as well as, you know, a continuation of current, you know, rate of sales into our biopharma research environment. I think that gets you to the, the 600 basis points that you that you referenced. If you think about, you know, the phasing of that, as I suggested in my prepared remarks, you know, we anticipate, you know, Q3 and Q4, you know, having, you know, roughly equal levels of reported EBITDA, EPS, as well as reported, you know, revenue.

You know, as we're, you know, working our way through July, you know, I, I would just say, the experience we're having, you know, up, up till now, I, I think is consistent with how we're framing, you know, the outlook for the, for the balance of, of the year.

Tejas Savant (Executive Director and Senior Healthcare Equity Analyst)

The budget flush. Got it. That's helpful.

Michael Stubblefield (President and CEO)

Oh, yeah, you had one. Sorry, sorry. You had one more question.

Tejas Savant (Executive Director and Senior Healthcare Equity Analyst)

Yes, exactly.

Michael Stubblefield (President and CEO)

Let me, let me address that as well. If we think about, you know, the full year, you know, what we've tried to do here is just recognize the current macro environment, the trends that we saw in Q2, and extend those through the balance of the year. You know, that would, you know, really not contemplate much of any of a, of a budget flush this year.

Tejas Savant (Executive Director and Senior Healthcare Equity Analyst)

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

Michael Stubblefield (President and CEO)

Yeah. Thanks for the question on that opportunity to weigh in. Yeah, I think as, as you would expect, I think we continue to be rather bullish about our positioning within the end markets that we're serving. You know, one of the proof points I would point you to in this, is this quarter, as a validation of that is, you know, the strong growth that we delivered in the academic end market within the Americas. You know, we grew in that space, you know, double digits this quarter, which really is a reflection of the commercial intensity, you know, that we're driving across all of our end markets.

As, you know, end market health is, you know, recovering in certain pockets, you know, we're certainly, you know, there to, to grab our share, or in this case, probably more than our share of, you know, the available opportunities. We do track a lot of different metrics. We hold ourselves to a high standard here and, and, you know, do expect to, to grow in line, if not faster than our, than our end markets. Whether it is our digital traffic, you know, our win rates, you know, our share of our customers' R&D spend, you know, all of these things that we do look at real-time, and, you know, we continue to be very confident that we're well positioned in each of the end markets that we serve.

Tejas Savant (Executive Director and Senior Healthcare Equity Analyst)

Got it. Thanks for the time, Michael.

Operator (participant)

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

Michael Ryskin (Managing Director)

Great. thanks for taking the question, guys. First, I kind of want to go back and, and do a little bit more comparison of your commentary after the 1Q call and in May at some of the conferences and then today. I think previously, you kind of indicated that the majority of what you were seeing from Biopharma was destocking and, you know, underlying demand stayed robust, underlying churn, and you highlighted, you know, excipients, some of the special chemicals. That was a couple of months ago. Now, it seems like you're having a little bit more color on, you know, demand weakening. I was wondering if you could just elaborate on that. You know, you mentioned R&D a little bit. Anything you can delineate between R&D and production?

Maybe you could give us a magnitude for that demand weakening, you know, from an end-market perspective, how much has it slowed over the course of the quarter?

Michael Stubblefield (President and CEO)

Yeah, thanks for the question, Michael. you know, first, around destocking, I think, you know, from our perspective, the, the headwinds that we face, both in lab consumables as well as in our single-use solutions, I think we saw those destocking headwinds, you know, play out as anticipated. Consistent with, you know, previous reporting periods, you know, we, we have done a tremendous amount of engagement with our customers, and the data that we're getting from our customers would certainly support, significant improvement in inventory health, and, you know, which gives us some encouragement going forward.

Relative to what we saw as we moved through the quarter, you know, in addition to the destocking playing out as anticipated, we did see, you know, a market slowdown in overall demand in the production environment as our customers adopted a bit more, you know, cautionary approach as we moved through the quarter. You know, part of that is certainly linked to them managing their own working capital and their own end market, or their own end product, you know, inventories. You know, part of that also reflects our improvement in lead times, but we do see, you know, campaigns and projects getting, you know, pushed out into, you know, latter parts of the year into next year.

On the R&D side, you know, similar type dynamics in that as we moved through the quarter, you know, we started to see, you know, constrained spending of their, their capital budgets, you know, reflected in our equipment and instrumentation category, which I think we, you know, highlighted at a number of the, you know, public remarks we made in, in the quarter. Then we also saw, you know, more, a constrained approach to how they were, you know, spending across consumables and other categories as, you know, they, you know, implement their own productivity actions around, you know, site closures and headcount reductions. Certainly, we did see an impact on overall activity level in the quarter, which was a little bit of a change from what we'd seen in previous quarters.

Encouraging, though, as Tom mentioned in, in his remarks, we did see, you know, a, a stabilization within the biotech, you know, space, which was off, you know, significantly in, in Q1, and, you know, we, we saw it, you know, stabilize in, in Q2. Those are, you know, a few of the things that we saw in the quarter, Michael.

Michael Ryskin (Managing Director)

Any way to just put a number on that? You know, let's say that our market used to grow 5%, is it down to 3%? Is it 0%? Is it -5%? Just give us some sense of, how much demand slowed.

Michael Stubblefield (President and CEO)

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

Michael Ryskin (Managing Director)

Got it. Got it. That's helpful. Then just real quick on, on the margin guide, you know, appreciate some of your color on, on the puts and takes there, but if I'm doing the math right, it still looks like you're guiding to about 100 basis points sequential decel in margins. You're guiding to about 18.7%, 18.8% EBITDA margin in the second half versus 19.7% in the second quarter. About 100 basis points drop off on revenues that are relatively consistent on a dollar basis. Is there, I mean, just sort of what's driving that? Is it mix shift away from proprietary? Is it less price? Is there some added cost coming in in the second half? Just walk us through the margin bridge to 2H.

Michael Stubblefield (President and CEO)

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

Michael Ryskin (Managing Director)

Okay, thanks.

Operator (participant)

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

Luke Sergott (Director of Healthcare Equity Research)

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

Michael Stubblefield (President and CEO)

Yeah. Good morning, Luke. Good to hear from you. You know, as we have talked about in previous quarters, you know, we've been seeing somewhere on the order of, you know, 500 basis points-600 basis points of, of destocking in our, in our business. You know, I think that's, that's, you know, consistent with our experience in, in the second quarter.

We have a new variable, a new dynamic, though, that is making, you know, the, the ability to, to give a precise number for destocking a little bit more challenging as we move into the second half of the year, because we're also now starting to see, or we did see a deceleration in just overall, you know, demand within, you know, the bioproduction space, you know, linked to, again, you know, a more cautionary approach and a, and a push out of, of some of the, the projects and, and campaigns. At this stage, it, it is difficult to, to kind of parse that between demand versus destocking since, you know, it's, it's pretty widespread at this, at this stage. I would point you to, you know, the, the data that we have on our customers' overall inventory health.

You know, this is, you know, something that we've been really close to for, you know, nearly a year now. What we're seeing there is continued improvement. You know, the survey data and the feedback from our customers continues to, to trend in the right direction. You know, I think when I look at, you know, where our customers' inventory is of these destock categories, or these overstock categories and, you know, how they're thinking about, you know, forward demand, it is encouraging. When I look at, within bioproduction, the category that was, you know, most overstock was in our single-use platform. I referenced, you know, in my commentary, you know, one of the leading indicators that we look at in that particular business is overall engineering drawing activity.

That's really the start of a, of a customer's, you know, demand, and it kicks off the whole process. We have seen a, a market uptick in engineering activity as we, as we got into the second quarter. You know, that'll take time to convert into orders, and then, you know, there's a lead time on the back of that to get into revenue. That is another signal that, you know, gives us some, you know, encouragement as we think about our current environment.

Luke Sergott (Director of Healthcare Equity Research)

All right, great. Just two quick follow-ups. I guess, on when you're talking about engineering drawing, I live my life behind Excel, so I have no idea what that means. Can you help to like, justify or not justify, help lay it out, like before, you know, the time frame of when you're starting to see the engineers draw up the plans, like, for what drugs are they doing? By the time they start placing orders and manufacturing drugs. The follow-up on that would be, you know, you talked about the inventory surveys looking better. Have you built any of that into the guide, or is this, could this be a source of upside for the back half of the year?

Michael Stubblefield (President and CEO)

Great questions, Luke. On the engineering activity, as we've talked before, you know, our single-use platform, it's a, it's a custom platform where we're designing custom assemblies and manifolds and connectors, and every, you know, opportunity that we have with our customers is gonna be unique and requires custom engineering. They'll come to us with a, with a request for a, for a design. Our engineers will, will go to work and turn around a design. We'll collaborate with them, and then, you know, ultimately, that'll, you know, hopefully translate into, to an order. That whole process can take a few months from when that is kicked off to when, you know, it ultimately manifests itself in a, in an order that they're ready to move forward with.

You know, depending on what it was, you know, we obviously have lead times that, you know, could, could be in a two- to three-month time frame for, for building those, those products. Hopefully that gives you some color to what that would look like on a leading indicator basis. Just in terms of, you know, what we've built in here, in terms of some of these, these positive signals, I just take you back to what we've said about how we've guided. You know, we're grounded in the, the conditions that we experienced in the second quarter, and we've extended those through the back half of the year.

To the extent that there was, you know, a material improvement, or I guess, you know, a material deterioration in either direction, you know, that wouldn't be contemplated in our current numbers.

Luke Sergott (Director of Healthcare Equity Research)

Great. Thank you.

Operator (participant)

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

Vijay Kumar (Senior Managing Director)

Hi, guys. Michael and Tom, good morning. Thanks for taking the question. Just one on revenues here. What was China in the quarter? You mentioned back half guidance is contemplating, you know, second quarter trends. I'm curious, July, it looks like things worsened in second quarter, right, when you think about the phasing. When you look at the July exit rates, are we, are we at the, you know, are we seeing an improvement versus, you know, June, or are we at the levels as seen in June?

Michael Stubblefield (President and CEO)

Yeah. Good morning, Vijay. Thanks for the questions. you know, on China, I, I think it's, you know, we've been clear that, you know, we don't have a significant exposure there in China. It's a few percent of our overall revenues. I would say that, you know, the, the trends that we saw in, in the second quarter are consistent with what you've heard, you know, others report. It is weak and, you know, not particularly constructive at the moment, and that gets reflected then in the overall, you know, performance that we delivered in the AMEA region. When I look at, you know, kind of China being, you know, a source of weakness, I combine that with, you know, the semiconductor headwinds that we have in the region as well.

Those are the key drivers for, you know, the, the print that you see there for the AMEA region. It does really, the, unfortunately, mask some pretty, you know, positive signals in our bioproduction business in Korea and in Southeast Asia, where, you know, we continue to see, you know, pretty strong, you know, core organic revenue growth. Certainly, China is a drag at the moment. Then in terms of, you know, what we're seeing in, in July, you are correct that we did see, you know, kind of sequential, you know, weakness as we moved through the second quarter. I think our experience in, in July, you know, does, does reflect, you know, what we were seeing there, you know, toward the end of the, the quarter.

Is certainly contemplated in our, in our view, that it's prudent at this stage to extend those second quarter, you know, trends through the back half of the year.

Vijay Kumar (Senior Managing Director)

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

Thomas Szlosek (EVP and CFO)

Yeah. Just a couple of things to unpack there, Vijay. You know, first of all, on the, on the, you know, the, the sales versus the EPS, you know, revision in the total year guidance, you know, at the midpoint, it's roughly $0.20, or $0.24. I'd say that, you know, 60% of that is just from the top line. I mean, at the midpoint, there's probably $400 million or so of sales coming out. If you take that out at the, you know, at the margin rate, that, that gets you about 60% of that.

The balance is the combination with lower gross margin rate, because as, as Michael talked about, fair amount of the sales reduction, you know, for the second half, is in proprietary products, which are, you know, margin rich for us. You got, you, you have maybe 100 basis points pressure on the gross margin rate in the second half. You know, what, what you see then is, you know, between the two of those, you know, that, that, that's most of the, of the, the EPS impact. A little bit of favorability on, you know, on the TOE side, like SG&A, probably $0.06 or so, and the balance is noise between tax and interest.

It's primarily top-line driven, little bit of gross margin rate and offset by productivity. We do have, you know, productivity, you know, additional productivity coming through. When you look at the, you know, the first or the second quarter, you know, we were, we were down on the margin rate, probably had 350 basis points of pressure from, from the top line, you know, just volume as well as the margin rate from the higher proprietary products coming out. You did see some nice offsets, you know, on the SG&A side, as well as some other productivity initiatives in the supply chain, you know, that helped us to, to offset that and deliver the 19.7%. I would say those same factors are in play for, you know, the full-year guide.

While we still expect, you know, that adverse mix impact that I talked about, we will, we will continue to get, you know, productivity offsets. We've, you know, in my commentary, use the words double down. You know, we already had coming into the year, a number of different, specific, productivity projects on top of what we normally do around productivity, you know, site closures and, you know, delayering and so forth. You know, we've, we've identified additional opportunities. In addition, as you would expect, you know, Michael's got the team, you know, going after discretionary spend and, you know, some other productivity things. Pretty confident that, you know, that, you know, the margin rate, we're, you know, we're able to offset some of that, some of that top-line impact.

Michael Ryskin (Managing Director)

Understood. Thanks, guys.

Operator (participant)

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

Rachel Vatnsdal (VP of Equity Research)

Great, good morning. Thanks for taking the questions. I wanted to follow up to an earlier question around bucketing the guidance cut. I believe you had said 100 basis point-miss, and then the rest of the guide cut was split between bioproduction and biopharma. Could you just walk us through your updated expectations for instrumentations and equipment? Are you seeing any incremental weakness in that instrumentation business, especially within distribution channel? On semiconductors, are you expecting any incremental weakness there, just given the prior guidance and then the 75% decline this quarter in that market?

Michael Stubblefield (President and CEO)

Yeah. Good morning, Rachel. Thanks for the question. A couple of, of things to unpack for you there. On equipment and instrumentation, if you recall, in the first quarter, we were down low to mid, low, low single digits, and as we showed in our, in our materials, we were down mid-single digits in the quarter. That was pretty pervasive. That was across really all of our end markets. We certainly saw it in our, you know, Biopharma R&D, but it was, it was also in, you know, our other end markets as well, as we just do see customers taking a more cautionary, you know, approach to, to capital, you know, spending.

When you think about your question around semiconductors, it, it played out, you know, as, as in, you know, roughly in line with our expectations for the second quarter. It was a little bit weaker, perhaps, but, you know, more on the margin. What we've baked in for semiconductors in Q3 and Q4, consistent with our overall approach to our guide, is that those conditions would persist, which, you know, hopefully proves in, in this case to be a bit conservative. If you listen to some of the commentary from our customers, as they're in the middle of their earnings seasons, you know, you do sense a, a pickup in sentiment and, and outlook, and, you know, we're hopeful that, you know, that that translates into, you know, better performance in the second half of the year.

What we've assumed for semiconductors is similar, you know, levels, that we, as we saw in the second quarter, persisting through the balance of the year.

Rachel Vatnsdal (VP of Equity Research)

Great. Thank you for that color. Maybe just shifting over to more bioproduction, biopharma. Can you talk about how many months of visibility you have in bioproduction right now, given the destocking and demand dynamics? Regarding a comment of weakening demand at large to mid-size biopharma, can you talk about your conversations with those customers? How likely is it that we could see a catch-up in spending later this year, or are budgets really getting cut for 2023 based on your conversations? Lastly, how are those customers thinking about project level on activity heading into 2024? Thank you.

Michael Stubblefield (President and CEO)

Firstly, on bioproduction, you know, consistent with what we've said before, we do have, you know, a historically high, you know, order book and, and backlog. We're still probably, you know, more than 2x of orders in hand than what we had on kind of a pre-COVID level. Now, that has been normalizing as we've moved through the year, consistent with, you know, improving lead times and, you know, consistent with some of the destocking dynamics that we've seen play out as we've moved, you know, through the year. But we're also, you know, seeing, you know, just an overall reduction in overall, you know, demand as, as well at the moment, but, you know, pretty strong order book.

Now, as that, you know, gets phased into a, a particular, you know, reporting period or a particular month, we would, you know, generally have, you know, maybe you know half of the demand, that we might expect to service in a given month, you know, in an order. We, you know, we would take orders throughout the month on, you know, some of the portfolio that has, you know, shorter lead times. You know, we typically think about visibility there in terms of two to three months. On a, on a forward basis, that would only probably cover, you know, maybe 50% or, you know, 60% of the demand that we would expect to serve in that, in that particular period.

In terms of the research space, you know, you know, structurally, it's a little bit difficult to, you know, to look ahead at, just given the short order cycle nature of that business, where we have, you know, more than 6 million SKUs, we're serving more than 300,000 customer locations. You know, you get more macro-level commentary from your customers as opposed to specific forecasts that can translate into, you know, demand planning. As we said before, you know, limited visibility on a forward basis there.

you know, as you see, you know, our customers roll through their earnings seasons and, you know, ongoing announcements of, you know, reductions and reprioritizations of pipelines and, you know, more constrained spend and a focus on productivity, you know, that is certainly, you know, being reflected in the, the high single-digit decline that we saw in, in the second quarter. It's, you know, our expectation, at least based on the way we've modeled it, is that we would continue to see that as we move through the balance of the year.

Operator (participant)

Our next question comes from the line of Matt Sykes with Goldman Sachs. Matt, please go ahead. Your line is open.

Matt Sykes (Managing Director and Senior Equity Research Analyst)

Hi, good morning. Thanks for taking my questions. Maybe just following up on your comments about biotech, seeing some level of stabilization. Understand that there are pretty large differences in the funding dynamics for small biotech and large biopharma, but does that stabilization give you kind of any sort of phasing information in terms of how large biopharma might recover? Is this sort of a first in, first out dynamic, or do you think those two customer cohorts are different enough due to the funding dynamics and other things, that that's not the case?

Michael Stubblefield (President and CEO)

Yeah, thanks, Matt. I'm not sure I would necessarily try to link those two segments, what we're seeing there. The, the funding dynamics are, are quite different in, in, in both cases. It is encouraging to, you know, the trends that we are seeing on, on biotech. I mean, I think there was a, a bit of a uptick in funding in the, in the quarter, and certainly when we look at our, you know, sales to that segment, it was, you know, quite similar to what we saw in, in Q1. We're hopeful that, you know, that trend continues and that, you know, maybe we're on the way to, you know, to recovery there.

I would say that the drivers and, you know, the, you know, the priorities of the two segments are, are, are different enough that I, I probably wouldn't try to correlate those two, Matt.

Matt Sykes (Managing Director and Senior Equity Research Analyst)

Great. Thank you. Tom, just on pricing, can you just kind of talk about what you achieved in terms of pricing in, in the second quarter and what your expectations are for the back half of this year?

Thomas Szlosek (EVP and CFO)

Yeah, it's largely played out as as we would have expected, you know, in terms of, you know, the guide that we gave. It continues to be a, you know, fairly healthy pricing environment for us. You know, not as robust maybe as 2022 as we had, we talked about initially, but, you know, it's held up really well. I think the frequency of price increases is probably gonna, you know, normalize here. I mean, you know, given the inflation that was, you know, coming through in 2021 and more so in 2022, there were, you know, a more robust cadence of increase. I think we're, you know, more returning to normal on that front.

The, but the overall quantum of it is, is, has been similar, a little bit high by historic standards, but, you know, largely in line with plan.

Matt Sykes (Managing Director and Senior Equity Research Analyst)

Thanks.

Thomas Szlosek (EVP and CFO)

Thanks.

Operator (participant)

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

Patrick Donnelly (Managing Director)

Great. Thank you, guys. Maybe just another one kind of following up, I think it was Michael's question earlier on the, on the second half margin implication. You know, obviously, the exit rate is going to be quite a bit lower than, than expected. I think the Street is somewhere around 21% EBITDA for next year. You guys have these cost containment measures in place. I, I guess, how quickly can you see, you know, those take hold and then drive some expansion or, or protection of the bottom line? Just trying to figure out, I guess, how much of these headwinds linger into 2024, particularly on the margin side, you know, given that second half guide, versus, you know, kind of inflecting back.

You kind of mentioned things like pricing and, you know, it would, would be good just to get a handle on, on the moving pieces and the dynamics as we look ahead.

Michael Stubblefield (President and CEO)

Yeah. Thanks, Patrick, for the, for the question. You know, probably not, you know, surprising as we think about, you know, where we sit here in the, in the calendar and the dynamic environment that we're in, you know, it's, you know, it's, it's pretty difficult to provide a whole lot of color as to what we might anticipate in, in 2024, given, you know, what's driving our business at the moment is, you know, the, the macro economy and, and not something, you know, so specific that we can isolate to our, to our own business. That, you know, certainly challenges the, the visibility.

We'll, we'll work through the balance of the year here and, you know, through our normal cycle here, we should, you know, be able to give you some, some transparency and color on how we see next year shaping up as we get a little bit closer to that. I would, you know, point you to, you know, the second quarter as kind of the proof point of, you know, our focus on productivity and, and how that is getting reflected. We are getting significant contributions from our cost controls and our, you know, ongoing investments in efficiency and in continuous improvement. You know, the thing to keep in mind about our business is. We've got a long-standing track record of this, going back to the IPO.

You know, every year, we've expanded margins by over 100 basis points. So, you know, in an environment like this, that culture of continuous improvement, you know, certainly does serve us well. We've doubled down on that, given the environment, and, you know, driven incremental actions that is flowing through, as you see in the second quarter. You know, we're able to offset, as we move through the balance of the year, you know, more than 200 basis points of volume and mix headwinds, you know, through the productivity actions that we're taking. Would, you know, anticipate these things to carry into, you know, into next year.

Patrick Donnelly (Managing Director)

Okay. That's helpful. Then maybe just two clean-up questions on the guide. Can you just refresh us on kind of the full-year bioprocessing guide, and then the semis guide as well? I think you said it was down $80. You know, where's the bottom there, and visibility would be helpful. Thank you, guys.

Michael Stubblefield (President and CEO)

On bioproduction, Patrick, probably the best way to think about that on a core organic basis for us, you know, we had modeled that at, you know, kind of down mid to, to high single digits, is, is what I'd point you to, there. The, the COVID headwinds are, you know, playing out as anticipated there, to get to an organic number. Then on the semiconductor, you know, space, we have modeled, you know, Q3 and Q4 similar to Q2. As I said earlier, we are encouraged by, you know, what we're hearing from our customers here as they work through their earnings season and disclose their, their results. Certainly you see a, a more positive turn in their, in their sentiment.

We are starting to see some of that getting reflected in the, the outlooks, the midterm outlooks that they're giving us. You know, could be some upside there. The way we've modeled it in our guide would be continuation of Q2 trends.

Patrick Donnelly (Managing Director)

Helpful. Thanks, Michael.

Operator (participant)

Our next question comes from Justin Bowers with Deutsche Bank. Please go ahead, Justin, your line is now open.

Justin Bowers (Equity Research Analyst)

Hi, good morning, everyone. Just wanted to understand some of the customer inventory surveys you were referring to, and it sounds like it was in, in, in Biopharma. Any thoughts on when sort of the destocking element troughs? It sounds like it was, it was sort of stable and in line with expects QoQ. Does that, you know, point to some green shoots with respect to 2024 in, in that part of the business? Then just a refresher on trends in that business or performance in the business in 1Q and 2Q, because I think you said it was a 10-point swing between the quarters.

Michael Stubblefield (President and CEO)

Yeah, thanks for the question, Justin. On these, you know, customer surveys and the, you know, the engagement that we have with our customers, I do view that as, you know, one of the bright spots, you know, in a, in a rather, you know, challenging market environment. There's probably two things I would point you to there. You know, one of the things what we're testing for in those, interactions is just, you know, how much inventory do you have, you know, relative to your target? Of course, we can then track that as we've, you know, been, you know, consistent in our surveying over the last number of, quarters. As we did that again, you know, here over the last several weeks, that inventory health has definitely improved.

Meaning, you know, the, the amount of overstock that's in the channel that's being reported by our customers has definitely come down, you know, pretty meaningfully. And, you know, certainly it, you know, it, it does reflect, you know, you know, the dynamics that we were, we were hopeful to see there. The second piece that we also test for there is, just a little around, around sentiment, in terms of, you know, as you think about where you sit here today, you know, which direction do you see your demand going? And, you know, the percentage of customers that are, you know, I would say, responding to that favorably, you know, meaning that they would see, you know, you know, demand to pick up, you know, also, you know, is, is moving in the, in the right direction.

Now, you know, those are, you know, encouraging signs. You know, I'd be hesitant to, like, you know, to call, you know, the bottom or, you know, we, we have not yet seen to be clear, you know, an inflection in order books or, or certainly in daily rates of, of, of sales. That's what ultimately we need to see to, you know, to have the proof that things have turned. There are a number of leading indicators across, you know, a lot of our end markets here, you know, that do give us, you know, some, some optimism. You know, where, you know, markets are healthy, you know, whether that be in our medical implants business or whether that be in academia, you know, you see that we are very well positioned.

We, we grow strongly, you know, where the, you know, the markets are conducive to that. That's, you know, another thing that feeds our, our optimism in our business.

Justin Bowers (Equity Research Analyst)

Appreciate it. If just one quick follow-up on the order book. The large order book, are you seeing any sort of timing issues there with customers in terms of maybe pushing back when they wanna take those deliveries or any change in sort of cancellation levels? Thought that would be a little, little more stable for demand throughout the rest of the year, but any, any comments there would be helpful.

Michael Stubblefield (President and CEO)

As you would expect, you know, we end up, you know, working quite closely with all of our, you know, customers to help them manage their, you know, production plans and their inventory levels. You know, consistent with what I said earlier, you know, we do see, you know, an increasing trend of, you know, project delays and, you know, campaigns that are getting either reduced in size or, or pushed out. Order cancellations aren't a, you know, a big part of our, of our business. It, it ends up being more of a, you know, collaboration with our customers in terms of how we, you know, schedule and manage the, the deliveries to, to best meet their, their needs.

You know, as we moved through the quarter, we definitely saw, you know, customers in bioproduction, you know, start to, you know, more actively manage their, you know, their campaigns and, you know, take a more cautionary approach to, to spend, you know, which gets reflected in the second quarter numbers as well as, you know, the roll-through into our full year, full-year guide.

Justin Bowers (Equity Research Analyst)

Understood. Appreciate it.

Operator (participant)

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

Michael Stubblefield (President and CEO)

Yeah, thank you all for participating in the call today. I certainly look forward to updating you when we get a chance to meet next. Until then, be well, everyone.

Operator (participant)

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