Avantor, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the Appentard Second Quarter 2020 Earnings Conference Call. At this time, our participant lives on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press Star 1 on your telephone. If you require any further assistance, please press Star 0. I would now like to hand the conference over to Mr. Tommy Thomas. Thank you. Go ahead.

Thank you, Operator, and good afternoon, everyone. Thank you for joining us on today's call. Our speakers today are Michael Stubblefield, President and Chief Executive Officer, and Tom Slozek, Executive Vice President and Chief Financial Officer. The press release and presentation accompanying this call are available on our investor website at ir.avantoursciences.com. A replay of this webcast will also be available on our website following this call. Following our prepared remarks, we will open up the line for questions. I would like to note that we'll be making some forward-looking statements within the meaning of the federal securities laws, including statements regarding events or development 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 made today. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update these forward-looking statements, whether a result of new information, future events, and developments or otherwise. This call will include a discussion of non-GAAP measures. A reconciliation of these non-GAAP measures can be found in the appendix to the presentation. With that, I will now like to turn the call over to Michael. Michael?

Thank you, Tommy, and thanks to all of you for joining us today for our second quarter earnings call. I'm starting on slide three with a brief review of Avantor's revenue profile. You've heard me mention before that our business model is very resilient due to our diversified revenue base combined with the customized nature of our solutions. We are well positioned for continued growth in Europe and the Americas, and we are investing to expand our capabilities in emerging markets throughout Asia, the Middle East, and Africa. More than 85% of our business is recurring, and approximately half of our revenue comes from proprietary-granted products and services. No single customer represents more than 3% of our revenue, and approximately two-thirds of our revenue is in attractive life science and markets, such as biopharma and healthcare. Our financial results for the second quarter, which I'll elaborate on in a moment, further substantiate our resiliency. The second quarter was the first to be fully affected by the global COVID-19 pandemic. Our business was adversely impacted by lab closures across the R&D and academic landscape, as well as by declines in elective procedures. However, we were able to offset most of the headwinds with new COVID-19 related opportunities in diagnostic testing, vaccine and therapy development, and clinical trial support. Moving to slide four and our second quarter business highlights. Despite the challenging environment resulting from the gold pandemic, our dedication to our customers has not wavered. Our distribution, research, and manufacturing sites have remained fully operational. Our broad customer access and extensive portfolio of products and workflow solutions to support patient testing, research and development, clinical trial services, and ultimately the production of approved treatments and vaccines make Avantor an important partner. We are actively working with many of the world's leading pharmaceutical and biotech companies as they develop and test potential COVID-19 therapies and vaccines. Our comprehensive bioproduction portfolio is being leveraged in most of the leading COVID-19 vaccine candidates across all major technologies, including recombinant proteins, viral vectors, mRNA, and DNA. Our direct involvement in government-sponsored initiatives, such as Operation Warp Speed in the United States, is another proof point of our relevance in the race to combat COVID-19. Of course, the health and safety of our associates who are working at our distribution, research, and manufacturing sites remains a top priority. We continue to comply with local statutes as well as guidelines from credible health agencies around personal protection, workplace density, symptom monitoring, and symptom identification and reporting. Our sales, customer service, and support personnel continue to work from home throughout the quarter. We have carefully developed plans to return some of these associates to work sites and will begin to implement those plans in the third quarter as local conditions permit. Our second quarter results reflect the power of our operating model in even the most challenging conditions. Reported organic revenue declined only 2%, including COVID-19 tailwinds of approximately 500 to 600 basis points. Despite the organic revenue decline, the resiliency of our model enabled us to expand our adjusted EBITDA margins by 94 basis points, grow adjusted earnings per share approximately 33%, and continue our strong cash generation. Earlier this month, we refinanced $2 billion of our high-interest debt, which will result in cash interest savings of more than $90 million per year. As part of the refinancing, we also extended our liquidity by doubling the size of our revolving credit facilities. Our improving balance sheet and favorable outlook resulted in another credit rating upgrade, giving us the opportunity over the next few quarters to further reduce interest costs by lowering the rates on the remaining $3 billion of debt. Our mission drives our deep sense of purpose to create a better, more sustainable world, and our teams have been actively engaged on improving the transparency of our environmental, social, and governance, or ESG reporting. We are pleased to have published our 2020 Corporate Social Responsibility Benchmark Report and look forward to sharing more information about our ESG priorities in the coming months. We've also taken a number of recent actions to reinforce our commitments to providing a positive work environment where all associates feel respected and have an equal opportunity to contribute and succeed. There is no place for racism, prejudice, or hatred of any kind, and we're actively focused on making the company a role model for diversity, equity, and inclusion. Turning to slide five of the presentation, I'd like to share a few financial highlights from the quarter. Organic revenue declined 2% as COVID-19-related headwinds in our education, healthcare, and applied end markets more than offset continued high single-digit growth in our biopharma business, where demand continues to be strong globally, especially in bioproduction, where we realized more than 20% growth in the quarter. Included in our results are approximately 500 to 600 basis points of COVID-19-related tailwinds as we realized incremental revenue associated with higher sales of PPE, qPCR testing kits, qPCR reagents and consumables, serological test kits, and proprietary materials being used to support vaccine and therapy development. Adjusted EBITDA on the quarter was up approximately 3% on a constant currency basis, and adjusted earnings per share increased approximately 33% to 19 cents per share. We continue to generate strong cash flow with first half free cash flow up over 300 million from 2019, enabling continued reduction in our net leverage to 4.3 times EBITDA, down from 4.6 times at the beginning of the year. We remain committed to continued deleveraging as we approach our target leverage range of two to four times EBITDA. As I prepare to turn the line over to Tom to discuss the financials in more detail, I want to emphasize that Avantour's mission of setting science in motion to create a better world is more relevant now than ever before. And our second quarter and first half 2020 results are evidence of the mission critical role we play in supporting our global customers. We are well positioned with a highly recurring revenue base, deep customer access, significant exposure to attractive end markets like biopharma, and a strong culture of execution enabled by the Avantor business system. With that, let me turn it over to Tom.

Thank you, Michael, and good afternoon. Let's start on slide six. Organic revenues declined 2% in the quarter, which, as Michael mentioned, includes a 500 to 600 basis point tailwind from COVID-19 related to PPE, diagnostic testing, vaccine and therapy development, and clinical trial support. These tailwinds were more than offset by the pandemic-driven headwinds, including our education and government business, reflecting the widespread academic lab closures. We also experienced impacts from commercial lab closures as well as declines in our healthcare business, reflecting temporary declines in elective surgical procedures and in our industrial businesses. Looking at growth from a regional perspective, the Americas, which represents approximately 60% of global sales, reported 6.7% organic revenue decline in the quarter. The region's sales were impacted by academic and commercial lab closures, fewer elective procedures performed by customer and a broad reduction in sales of equipment and instrumentation. Biopharma production and clinical services were bright spots for the Americas, each growing double digits. Europe, which represents approximately 35% of global sales, reported 3% organic revenue growth, driven by the strong performance in the biopharma and healthcare end markets, offset by COVID-19-related declines in the healthcare, education, and industrial end markets. The stronger second quarter growth rate in Europe versus the Americas reflects the lower exposure in Europe to academic labs and elective procedures and a higher participation rate in the COVID-related testing opportunities. EMEA, representing approximately 5% of global sales, reported an 18.2% organic revenue increase. Revenue growth was driven by the biopharma and advanced technology in applied materials and markets. Slide 7 shows our organic revenue growth by end market and product group for the quarter. What is notable on the slide is the two areas where we achieved high single-digit growth in the quarter, the biopharma end market on the left side of the slide and the proprietary product group on the right side. These are our most significant and higher profit categories, and their continued strength, despite the overall modest sales decline, was a big factor in the nearly 100 basis point expansion in adjusted EBITDA margins for the court. Biopharma, representing approximately 50% of our revenue, once again experienced high single-digit organic revenue growth. Strength came from our biopharma production platform, including single-use solutions, production chemicals, personal protective equipment, and clinical services. Healthcare, which represents approximately 10% of our revenue, declined high single digits, impacted by a reduction in elective procedures and routine clinical diagnostics. Education and government, representing approximately 15% of our revenue, experienced organic revenue declines of over 20%. This end market was impacted by the full or partial closure of academic and government research labs and K-12 schools for the majority of the quarter. Advanced technologies and applied materials, representing approximately 25% of our revenue, experienced mid-single-digit organic revenue declines. Economic weakness impacted our industrial segments with modest offsets in our non-industrial segments, including solid growth in the electronic materials business. By product group, proprietary materials and consumables experienced high single-digit growth with strength in the Americas and EMEA. Services and specialty procurement declined mid-single digits, impacted by lower demand for our specialty procurement services. Equipment and instrumentation was down mid-teens, reflecting CapEx investment declines across our customer base. In July, the biopharma momentum has continued with strong growth in lab products and biopharma production. We are actively engaged with our supplier partners and customers on offerings to support diagnostic testing, vaccine and therapy development, and clinical trials. For the other end markets, the COVID-19 impacts we experienced in the second quarter have moderated slightly. Labs in the academic end market have slowly started to reopen. We also expect modest sequential improvement in healthcare as elective procedures slowly resume. The industrial portion of the advanced technologies and applied materials end market also continues to see modest improvement. Considering these factors, we expect July's revenues to be approximately flat or grow low single digits versus 2019. However, given the ongoing uncertainties around the intensity and duration of the pandemic, we will continue to refrain from issuing guidance. Turning to slide eight, let me start with our second quarter adjusted EBITDA. Excluding foreign exchange, we achieved 3% growth in adjusted EBITDA and 94 basis points of reported margin expansion. Key drivers of the performance were commercial excellence, favorable mix, including strong growth in biopharma production and proprietary offerings, productivity, and continued discretionary cost containment. Free cash flow improved nearly 100 million to 76 million, reflecting stronger adjusted EBITDA, better working capital performance, and lower interest and tax payments. First half free cash flow generation of 316 million, or 136% of adjusted net income, was seven times the prior year amount. We are on track to achieve or beat our original full-year free cash flow guidance of $450 to $500 million, recognizing that guidance has since been withdrawn. Finally, we reported approximately 33% growth in our adjusted earnings per share for the quarter, primarily reflecting strong operating performance, the ongoing reduction in interest expense from our deleveraging, and the improvement in our income tax rate. For the first half of 2020, we grew our adjusted earnings per share 46%, 36 cents per share. Slide 9 has our segment results. America has reported 210 basis points of improvement in adjusted EBITDA. Key drivers include commercial excellence, favorable mix driven by a higher proportion of growth in proprietary materials and consumables, productivity, and strong discretionary cost containment. The first half 2020 adjusted EBITDA margin expanded 90 basis points. Europe reported 120 basis points of improvement in adjusted EBITDA. Key drivers include volume growth, commercial excellence, favorable mix, productivity, and strong discretionary cost containment. First half 2020 adjusted EBITDA margin expanded 80 basis points. EMEA reported 330 basis points of improvement in adjusted EBITDA. Key drivers include volume growth and favorable mix. First half 2020 adjusted EBITDA margins declined 60 basis points. Let me move to slide 10. In this environment, we occasionally receive questions regarding liquidity. Like we did in the first quarter, we're providing a brief summary of our liquidity. You see on the left half of the slide our liquidity as of December 31st, 2019 and at June 30th, 2020. The June numbers are shown on a pro forma basis to reflect the July refinancing. As part of the refinancing, we more than doubled the size of our revolving credit facility to $515 million. Recall that in the first quarter of 2020, we expanded our receivable securitization line by $50 million. These facility enhancements and the continued free cash flow generation of the business have enabled a greater than 70% increase in our overall liquidity to $1,037,000,000, roughly 100% of our adjusted EBITDA. which is in line with our peer group. Both of these facilities remain undrawn. We have no significant debt maturities, and we have a CapEx-like business model. To summarize, our liquidity and cash flow continue to get even stronger, and we are committed to deleveraging, even in these challenging market conditions. Since the beginning of the year, we have reduced leverage from 4.6 times I'm now on slide 11, which summarizes our July debt refinancing. We recently received approval from our board to execute a comprehensive strategy to lower the cost of our $5 billion debt portfolio while preserving the existing covenant life and minimal principal service requirement features. This is a continuation of our move toward an investment-grade capital structure typical of a large-cap public company. After the first six to eight weeks of the pandemic, the high yield debt markets began to turn in our favor. Shortly after the July 4th holiday, we launched a $1 billion U.S. debt offering and a 400 million Euro debt offering to replace in part the 2.9 billion unsecured notes that were issued as part of the BWR acquisition in 2017. Each of the tranches offered was significantly oversubscribed, and we were able to upside the U.S. dollar piece, allowing us to replace the entire $2 billion in unsecured notes and achieve a composite coupon rate of less than 4.5%. This refinancing will generate close to $90 million of interest savings per year and result in a lowering of the weighted average cost of our entire debt portfolio by approximately 180 basis points. We incurred approximately $180 million in one-time cash costs, which will be recovered within two years under the new financing. In the third quarter, there will be a one-time charge to reflect the costs incurred on the early extinguishment of the 9% unsecured notes. We continue to monitor the remaining $3 billion of the debt portfolio for refinancing opportunities. On page 14 of the appendix, you can see that there are some additional costly pieces of debt remaining in that $3 billion, that we are eager to address, depending on the conditions of the pro rata and leveraged loan markets. With that, I will hand it back over to Michael.

Thanks, Tom. I'm on slide 12. We executed well in a challenging environment, and our top-line performance, strong EBITDA growth, outstanding cash generation, and continued deleveraging reflect the resiliency of our business model. Our ability to complete a debt refinancing in a challenging time like this highlights the value of our highly recurring revenue base, broad mission-critical product portfolio, and exposure to attractive end markets like biopharma. While the uncertainty associated with the current pandemic continues to make forecasting difficult for parts of our business, our long-term growth strategy remains intact, and we are steadfast in our commitment to help our customers combat this coronavirus by supporting ongoing initiatives in testing, vaccine and therapy development, and ultimately in the production of approved treatments. Our mission of setting science in motion to create a better world has never mattered more. I want to sincerely thank you for your interest and investment in the Montour and for your ongoing support. I will now turn it over to the operator to begin the question and answer portion of our call. Operator?

Another reminder to ask a question, that's star 1 on your telephone keypad. Star 1 to ask a question. And our first question comes from Tyco with J.P. Morgan.

Hey, thanks. Michael, the 500 to 600 basis point COVID tailwind for this quarter, can you just talk about where that's coming relative to the 50 to 100 basis points last quarter? Is it incremental products? Can you just provide a little bit more color on what's driving the step up?

Yeah, good evening, Tycho. Thanks for the question. We're getting some tailwinds across a few areas. We continue to see strong demand for PPE, which Our supply chain on that particular area is indeed constrained, and we're not able to satisfy all the demand that's coming our way. But you're seeing some contribution from incremental PPE sales. But the bigger tailwinds are actually coming from the work we're doing to support COVID testing, as well as vaccine and therapy development. We're pretty deeply engaged in providing support a large number of materials across the entire QPCR workflow as well as the lateral flow serological tests. And our proprietary materials portfolio is being broadly used in the process development of the various vaccines across all four of the major technologies that are in the front running the chase for a cure here. pretty well positioned across that space and we got quite a lot of traction in the second quarter in those areas.

And then a follow up just on EBITDA margins, obviously nice improvement despite the top line this quarter. Can you just talk a little bit about the levers, how much of this was DWR synergy versus other factors and sustainability going forward?

Tom, I'll take that one. When you look at the 94 basis points, it was a combination of factors. I think the more significant ones continue to be the mixed dynamic that we talked about. Of course, in the quarter, We had lower instrumentation equipment sales and other specialty equipment sales. And in replacement, we had better sales of some of our higher margin offerings. Michael mentioned a few of them, particularly on the biopharma production side. So that was a definite tailwind for us. We also continue to do a really good job of managing the price versus COGS inflation dynamics. and got a bit of a tailwind there. And then I'd say the third thing is just overall productivity, including discretionary cost control. I mean, obviously, nobody's traveling, so that helped us. But there are a number of other discretionary categories that we've been pretty careful with across the landscape. So I'd say those are the biggest drivers.

OK. Thanks, guys.

And our next question comes from Derek with Bank of America.

Hi, good afternoon. Hey, Derek. Hey, so I just was wondering, you know, when we looked at your compare the first quarter to the second quarter results and, you know, America's is a little bit stronger in the first quarter, you know, a little bit softer in the second quarter. Were there any, I guess, were there any stocking or pull forwards into that? I'm just sort of thinking about you know, the dynamics between the two? Because this is a question I asked last quarter. I just don't have any further color on it. And this obviously leads into the question of how should we think about the Americas and the Europe split as we head into the third quarter?

Thanks, Derek. When you look at the performance in the Americas in the first quarter compared to the second quarter, you'll know that there was only probably the last, you know, 10 days or so of the first quarter where we were really starting to see any impact of the pandemic hit the Americas. It obviously first started in Asia, spread to Europe, and was last showing up here. So we had relatively modest impacts, plus or minus, in the quarter, in the first quarter in the Americas, with the most significant impact being felt in the education, the higher ed space. Moving into the second quarter, obviously we have the full weight of the pandemic, you know, hitting our numbers for the quarter with, you know, April clearly being the low point with, you know, significant headwinds with, you know, more than half of the, you know, lab work in university space offline, you know, the slowdown in elective procedures and you know, just I would say routine clinical diagnostics, you know, falling off. And then you also had a more modest impact to, you know, biopharma R&D capacity in the quarter as well. So I don't think we would look at inventory as a driver of the comparison. I think the bigger issue is just the – you know, the amount of the first quarter that was exposed to the pandemic, you know, relative to kind of the full weight of it hitting in April.

And so just to follow up on that, when you look at your July trends and you talked about a modest improvement in the base, but what about some of the tailwinds that you saw, you know, that 500, 600 basis points of COVID tail in 2Q, is that something, a similar level we should expect in the third quarter?

Yeah, when you look at the categories that outline for Tyco around where we're seeing tailwinds, whether it be PPE or testing or vaccine therapy development, we're also doing a fair bit of support through our clinical trial services business in supporting the trials associated with the vaccine development. We've certainly seen each of those categories carry over with some strength into July.

But no comment on whether or not it's totally to know whether or not it's going to be the same magnitude. I'm just thinking about what some of the other companies reported. The organic revenue growth number has been a lot higher for the COVID tail than we would have thought.

Right. Yeah, I mean, in July, I think we've seen probably similar magnitude. I mean, you obviously see escalation on the number of tests that are being conducted around the country as we go forward each day. You see a lot of these vaccines now starting to progress towards late-stage clinical trials, which is driving more demand and more volume. It appears that certainly those fundamentals will be with us for the foreseeable future.

That safety category is we're on allocation with our customers and suppliers. There continues to be significant demand there. Michael mentioned that as one of the factors. Like you said on the On the biopharma production side as well, where we saw some good tailwinds, our backlog or open orders is very, very strong. It's up significantly. So we're continuing to see the demand pulls in those tailwind areas that you mentioned.

Great. And then it's when housekeeping FX hit to the top line for 3Q and the full year?

Yeah. Yeah, well, I mean, it's kind of tough with the way the FX rates have moved in the last two weeks. So, you know, we're continuing to look at it just on an organic basis and try and normalize that. Derek, maybe we can do some follow-up on that. But right now, the situation is a bit volatile, so it's tough for us to predict exactly what the FX impact is going to be for the full quarter when we're not giving you know, guidance on the full core. Thank you.

And our next question comes from Vijay with Evercore ISI.

Thank you for taking this question and asking that from the solid execution here. Mike, maybe a big picture one for you. The July guidance of, well, maybe not guidance, but I guess expectation for flat-to-upload signals, does that include the, I guess, the cold-tail windows and flat-to-upload signals for the base business? And I'm curious, you made some comments around vaccines. Are we now at a time point where you could perhaps frame the longer-term opportunity that change would mean.

Yeah, BJ, thanks for joining the call tonight. On your first question, regarding the quarter in July specifically, trying to give you a flavor here, recognizing we haven't quite completed the month of July yet, just trying to give you some color on you know, how we see things, you know, finishing up here as we sit here with a couple days to go and, you know, we're somewhere in that flat up, you know, low single digits. And that would be inclusive of any of the tailwinds that we're seeing in the business. On your second question about, you know, just where we're at with these vaccines and is it too early to, you know, start to frame in, you know, potential impact, it certainly is a little bit premature, but it's moving quickly. when you look at the front runners and even some of the second runners that are moving forward, you see a lot of promise across recombinant vaccine, viral vector vaccines, DNA vaccines, and then the Moderna mRNA vaccine and together with Pfizer. And when you look at our portfolio within bioproduction, we're going to be relevant across all four of these areas, Vijay. And as I mentioned in prepared remarks, we're working on all of the major programs that are out there and certainly being pulled into a lot of the activity and planning by the various governments around the world that are following these things as well. So we're right in the thick of things with doing all we can to support our customers in this. When you start to look at the impact that, you know, one of these vaccines, you know, could have, there's obviously a number of factors that play into this, including, you know, the number of doses, you know, that an individual patient needs to be given in order for it to be effective, you know, how many patients, you know, we look at the treat, is it a billion, is it, you know, seven billion, you know, which technology. The addressable market, as we look at it, is highly dependent on, you know, which one of these therapies, you know, ultimately prevails. And on the low end, you could be looking at adding tens of percents to our addressable market for bioproduction. And on the high end, Vijay, you could be looking at doubling our addressable market and then some in bioproduction. So pretty wide range of potential outcomes here. And I think that'll start to clarify here over the next few months as, you know, we start to get some feedback from these phase three clinical trials and we start to hone in on, you know, which one of these vaccines or which ones of these vaccines will make it to market first. But, you know, we're definitely going to be relevant here. It will have an impact in a pretty broad range at the moment. But, you know, I think we're optimistic about the role that we're playing here.

And then, Tom, one quick free cash question for you. That's a monster number. I'm just curious. Are there any, one, kind of related elements that can impact your free cash flow? You know, what's driving it? And does the debt increment and does that improve aid to free cash flow here? Thank you.

Yeah, I mean, thanks for the question, Vijay. You're breaking up a little bit, but relative to the first quarter and second quarter, I mean, you combined the first half very strong. And as you pointed out, I mean, we're over $300 million. We're about $320 million of free cash flow through the first half. Our original guidance was So we're at that 60% point of the high end, as you mentioned. And the performance has been so far driven by better performance on working capital, certainly. And, you know, as we've gone into the second quarter and look forward to the third and fourth quarter, we've got some other, you know, tailwinds that, you know, have emerged. I mean, certainly the, you know, the refinancing is helping us when we've lowered our interest bill significantly on a run rate basis for a full year by 90 million. So we should see, you know, somewhere on order of a little less than half of that in the second half alone. We're doing a lot better than we had expected on tax through a combination of both the CARES Act provisions that have helped the deductibility of our interest costs for both 2020 and 2019. And we've done well on managing risks on some refund applications. those should be coming through as well. So tax will continue to be a really good driver for the second half. So we're really optimistic we can continue the momentum. So if you were kind of looking at the second half, and if we were able to maintain a reasonable level of the flat to low single-digit growth that we're talking about in July, if you could keep that going, you would be looking at doubling the amount of cash for the full year on this basis. Now, we have to continue to manage working capital like we have, but if we do that, the other pieces are falling into place nicely. Yeah, we should we should continue momentum. Wow.

Thank you. And our next question comes from Doug with Cowan.

Hey, good afternoon guys. Thank you for taking my questions. Just starting at the follow up to what I think was DJ's first question on vaccines. It sounds like it's just too early for you guys at this point to quantify in dollar terms what the vaccine opportunity might be, just given all the moving parts, all the unknowns. That said, would you be willing to confirm that you believe vaccine production will drive an even further acceleration of growth within your bioproduction business versus already robust recent trends, given that things are just getting going there? At this point, it seems to us that bioproduction could keep growing more than 20% year over year for the next several weeks. Maybe next year, or maybe even longer. I just want to make sure we're thinking about it right.

Yeah, Doug, good evening, and thanks for the question. I think generally you are thinking about it correctly. When you look at the tailwinds that we've seen in the second quarter, you know, within the vaccine area. You've got to keep in mind most of that is, you know, or all of that is within just the process development and early phase clinical trial support, which, you know, you're talking relatively modest, you know, number of doses that we're supporting. And, you know, just given the breadth of our coverage here, the number of programs, you know, we're going to have exposure to most of the, you know, the nearly 200 programs that are out there across the main technologies that, you know, that are coming through here, I think it is reasonable to assume that when one of these hits, whichever one ultimately comes through, that it will have a meaningful impact on the business. When you look at our open order report, for example, and Tom referenced it. But, you know, since the pandemic hit, our open orders as we sit here today are up, you know, more than 40% and growing. And so we're seeing a tremendous pickup in the business. We drove, you know, more than 20% growth in the quarter. And, you know, I think we see that, you know, certainly continuing through July. And when you look at the strength of the order book, I think we're optimistic about where this has headed.

Okay, that is super helpful. And then moving down the P&L, gross margin increased 120 basis points year over year in the quarter, as you know. How much of the increase was driven by higher proprietary product mix? And then looking to the second half, assuming bioproduction and your other proprietary products continue outperforming, And then, you know, just layering in the fact that, you know, again, bioproduction is higher margin. Is 33% a reasonable floor, or is that even too low as the rest of the year?

Yeah, a couple things at work here. Certainly within the quarter, you know, the strength of the growth of our proprietary materials, you know, high single digits, was a significant contributor to the margin expansion that we didn't see in the quarter. It was also aided by, when you look at the headwinds in our business, primarily focused on some of the lower margin components of our portfolio, including our equipment and instrumentation offering, as well as our services platform. And so you're getting the double benefit there of really strong growth in the part of our business that carries the highest margins, and that the headwinds were primarily concentrated in the lower margin part of our business. We expect to continue to see strength in the proprietary offering within the portfolio, which will carry the margins with it. I think one thing to keep in mind, though, is as we see sequential improvement in, say, the education market, in the healthcare market, and in some of our applied markets, you know, where you see a more normalized, you know, product mix, you will start to bring back in, you know, some of the lower margin, you know, components of our portfolio, which will somewhat moderate the strength that we're seeing in the proprietary offering.

Yeah, and you also get, Doug, some, you know, at some point, you know, we get beyond this, you know, return some of those discretionary costs that we, you know, we need to, you know, reinvest in here. People will come back and want to see customers and incur a little bit of T&E. So that will be a factor we need to consider as we move forward as well.

Okay. And, Tom, if I could just sneak in one last one. Congrats on the refinancing, your highest cost debt. As you know, you still have a $1.5 billion slug of debt at 6%, well above where you recently refinanced. why wouldn't you refinance that debt as well over the next six months or so? And to be clear along those lines, does 2020 and 2021 interest expense guidance assume any incremental refis? Thank you.

Right. Second question first. No incremental refi benefit in what we have laid out in the chart on the interest expense going forward. On your first question, Really, when we set out to reconsider our capital structure, when we got into COVID, we were really melancholic about the impact that the rates were having. The high yield rates were, instead of improving, they were approaching 7% or 8% on the debt. And so we just took a pause. But over time, that just the high yield piece of the market seemed to improve in our favor. And we worked with our partners. They did a great job helping us to execute. And yeah, that was a good outcome. As for the rest, you're accessing other parts of the debt market, which have not yet returned to pre-COVID levels and are starting to moderate. But it's going to take some time. It clearly is our intention. work with our treasury team and the same set of advisors to get us to a point where we're in a position to do something on those higher cost pieces of debt. The exact time frame remains to be seen. It's really going to be market driven. I will say that when we look and we review the entire debt portfolio with our board and talk about the potential benefits that we saw from refinancing, I would say more than two-thirds of the benefit was in the unsecureds, which we've done. I don't want to hold out that we're going to be able to generate another $90 million of of annual savings. It will be meaningful, but I think we got the bulk of it with the first piece here. And we'll continue, to your point, over the next six months, maybe sooner, to address the other parts of the debt as well. Great. Thank you again.

Okay. Being mindful of time, please remember to ask one question and one follow-up question. And our next question comes from Jack with Nefron Research.

Hi, guys. Good afternoon. I was hoping you could comment a little bit more on what you're expecting in terms of the pace of academic and government and lab reopenings in the second half. And I think you're probably one of the companies that calls out K-12 exposure historically just maybe help us quantify, you know, whether you have a little bit of, you know, what that represents and how that might be impacted from COVID-19 specifically?

Yeah, Jack, happy to take the question on that. Obviously, the academic, you know, market for us has probably been the hardest hit of, you know, any of our end markets, you know, as the pandemic, you know, played out. And as we look at it, it probably hit a low point in April with, I think you can probably see a lot of the same publicly available information that we follow. But there was probably less than 20% of the scientific capacity at the bench at that time. And we saw incremental improvements as we moved through the quarter. And we've seen a steady progression through the month of July as well. Not fully back yet, I would say. And we track a couple of things. We track not only just the number of labs that are open, but we try to take a read on how much of the capacity in the lab is being used. And I think we're encouraged by some of the creativity that our customers are deploying there with implementing shift schedules and such to be able to get more of their scientists back in the labs. We're obviously supporting our customers' restarts and talking about how they're going to continue to progress. I think I would make one point here. It does feel like The return of scientists to the bench will be a separate activity from whether or not students come back to a campus in the fall, and I think we're encouraged that our original assumptions that that would happen do seem to be playing out. Our numbers in Europe, for example, I think are a little bit ahead of where we're at in the US, just given the timing of recovery there, and I think we're really encouraged by the momentum we have in Europe. And I think we're certainly not back at full run rates in the Americas, but certainly things are continuing to improve week by week there.

Great. And then I guess with the combination of the refinancing which took place and the outlook seems to be a little brighter today, Does it change the way you think about the pace of M&A and maybe just give us an update on how progress has been at building out the strategic development team?

Yeah, it's a great question. You know, we've been focused and continue to be focused as a priority of, you know, taking our leverage into kind of the target range of two to four times, and we're getting very close. You know, knowing that M&A isn't necessarily a linear event, you know, we kind of at the end of last year, early in the first quarter, started to rebuild our team, you know, put in place, you know, all of our processes and cadence and rhythm with our board. And, you know, we have been, you know, active throughout the year in, you know, building a pipeline, you know, engaging in a number of discussions. And we continue to be active in that regard. Certainly, the acceleration of cash flow and the strength of our cash flow generation is encouraging. When you look at the outlook for cash flow generation taking into account the improvements that we're making in the business and particularly the financing costs, we think we are well positioned to start to turn this part of our growth strategy on. Now, having said that, we'll be disciplined about it and I think we're really focused on you know, bringing in more proprietary technologies. We're very focused on looking at ways of strengthening our bio-production often, looking at ways of strengthening our life sciences portfolio within our, you know, lab workflows. And, you know, we'll continue to be opportunistic about, you know, extending our capabilities, you know, into Asia. So I think the filter is pretty clear that we're applying. And, you know, as we sit here at the end of July, certainly the size of the funnel and sophistication of the funnel is certainly far greater than it was, say, when we spoke 90 days ago. And so it's getting a lot of our attention, and we're anxious to put capital to work in that area.

Yeah, the one thing I'd mention on that, Jack, going back to the refinancing, I mean, that has moved our weighted average cost of capital, which obviously is a factor in our M&A consideration. I think that will make us more competitive in terms you know, in the way we, you know, pursue some of these deals.

Great. Thank you both.

And our next question comes from Patrick with Citi.

Great. Thanks, guys. Maybe just one on the industrial market trends. I'm just curious in terms of what you guys are seeing there on the more macro sensitive areas, your confidence in the outlook going forward. It seems like sentiment bottomed a bit in 2Q and maybe we're on the way back up, but Wondering what you guys are hearing from the customer base there and the visibility for the next couple of quarters.

Yeah, it's a good question. Certainly, we've been, you know, focused on, you know, I think when you look at our, you know, applied markets, as we've said before, it's roughly 25% of our business. You know, half of it is pretty sensitive to the macro environment. And so, as you suggest, You know, as we've seen, you know, the recession hit, that part of the portfolio has certainly been impacted the most and, you know, certainly off double digits. The other half of that, you know, end market is in more kind of defensive growth, you know, oriented applications, probably headlined by our exposure to the semiconductor space, which, you know, we play in a relatively unique way and, you know, we've continued to see nice growth momentum in that end market. But in things like oil and gas and pet chem that were really hardest hit by the pandemic, we do see some modest recovery starting to come back into the business. And I think when you look at the platform as a whole, given the depths of the pandemic and the recession, to have the platform off mid-single digits in the quarter. I do think it highlights just how diversified that part of our business is and how many levers there are to kind of keep that you know, keep that, you know, moving towards a positive direction. So I think we're encouraged by some of the factors we're seeing. Still, I think NatNet, we're, you know, probably still experiencing some headwinds in the month of July, but are hopeful that we'll see the trend continue.

Makes sense. And then maybe one for Tom, just on the margin side, certainly encouraging progress so far. Along with the internal initiatives you guys are doing, can you just help us think about the mix shift going forward? Again, things like vaccines have obviously been highlighted quite a bit here tonight. What's the mix look like as you look out a couple quarters? Is that going to continue to trend higher on the margin side?

Yeah, I mean, I guess if I knew the specifics of that, I was probably giving guidance, not to be smug, Patrick, but the you know, the dynamics that we've had in this quarter, you know, have helped to drive, you know, a good portion of that, you know, the EBITDA improvement. And, you know, it is a combination of the growth in, like the 20% growth in areas like biopharma production. But, you know, it's also helped by, you know, a moderation on equipment instrumentation, you know, like you're seeing in, you know, that landscape across the tools sector. And to the extent that starts to, you know, revitalize in the, you know, in the second half, third quarter, fourth quarter, that will moderate the margin expansion that we get from, that we continue to benefit from in the, you know, in these higher growth areas we've talked about. So it's a tough balance to call right now. Because, you know, it is a significant impact. And, you know, we'll continue to watch it and continue to keep you up to date on it. Okay. Thank you.

And our next question comes from Brandon with Jefferies.

Hey, thanks. Good afternoon. Mike, back on the bioproduction business, are you capacity constrained there at all, or are you seeing any areas where bioproduction Maybe you've got competitors that are seeing out of stocks and you've been able to actually capture some share.

Yeah, Brandon, thanks for the question. Within the bioproduction space, we do have a relatively broad and unique offering. As we sit here today supporting the clinical trial work, I think we're doing a pretty good job keeping up with really unprecedented demand that we're seeing in the business. I think where we spend our time on this topic, Brandon, is trying to project forward and obviously it's a pretty complex equation when you look at the number of programs that are in flight that we're working on, all different technologies and each leveraging certain portions of our portfolio. As an industry, we're facing really unprecedented potential demand. If you think about trying to provide a vaccine for the globe, at least as we sit here at the moment with what we know appears that it's not going to be one dose per patient, but it looks like it's trending towards multiple doses and probably annually. I think capacity is definitely going to be an issue for the industry as things start to move into commercial production across various elements. And I think we're all trying to figure out how you prioritize those bottlenecks and how you can get creative in bringing capacity to the market to support as much production as possible. So probably wouldn't look at it so much in terms of near-term you know, market share, you know, gain. I think the way we think about it is probably, you know, looking ahead at, you know, where the bottlenecks, you know, inevitably going to be for all of us. Just given, you know, the volumes that we're talking about here, it is going to stress, you know, the manufacturing capabilities and, you know, we're going to have to be pretty creative in, you know, how we de-bottleneck and how quickly we can make the capacity available.

Thanks. A follow-up for Tom. In terms of the COVID tailwinds of 5% to 6% in the second quarter, I'm curious if the exit rate in June was actually higher than that, if it scaled up through the quarter. And any chance you could share with us the impact of those tailwinds by geography between Americas and Europe? Quantify those specifically.

Yeah, I mean, the – I would just say overall our exit rates were positive in June relative to the entire quarter. And that probably was a combination of both further progress on the tailwinds as well as slight moderation on the headwinds. I think as we head into July that positive momentum on the exit rates continues. And I think as Michael said earlier, the mix of the tailwinds right now, I mean obviously we're not closed, but the mix of that tailwind looks like it should follow a similar pace that we had in the second quarter. Relative to the mix of the tailwinds amongst the regions, A little bit heavier in Europe, as you saw in the growth rate that we had there. I wouldn't say it was a material part of the growth differential. I think we were dealing more with the headwinds and the significance of the headwinds in the Americas being more pronounced with the higher concentration of academic and education in the Americas, which was obviously a headwind, as well as higher concentration of in the healthcare space in the Americans. Great.

Thank you. Okay. And our next question comes from Dan with the UBS.

Great. Thank you for taking the questions, guys. I joined a little late, but I kind of got the notes. I'm just wondering, I know there's no guidance for Q3 of the back half, but is it possible to give us a sense and give a lot of color on July trends and exit rates, but given you know, the repeatability, durability, consumer orientation of your, you know, kind of the consumable orientation of your business. I'm wondering if it's possible to even give us some flavor for a range or maybe help a little bit more on thinking through kind of an expectation for Q3.

Yeah, thanks, Dan. As Michael was alluding, and as we said in our prepared remarks, you know, the Exit rates in June have continued and have accelerated into July. And I think we're being reasonable with saying flat to low single digit growth. And I really wouldn't want to go beyond that point in terms of forecasting August and September. I mean, you've got a number of variables that work beyond just COVID, including, you know, seasonal vacations and shutdowns and things like that. We're not clear entirely how those will play out in this kind of environment. I think the variables around the duration and the extent, particularly when you consider some of the things that we're reading about, make it difficult for us to talk about demand patterns beyond what's right in front of us. we're a low backlog kind of business, you know, putting aside the biopharma production, you know, business. So most of it turns around at 24 to 48 hours from the time we get an order. And so it's, you know, we're sort of in a position where we know that, you know, we're well positioned, you know, with, you know, reordering and, you know, as things return. But it's, you know, predicting the precise nature of that is difficult, you know, from a timeframe perspective and from a, precision on the absolute range perspective.

Got it. No, Tom, that makes sense. And then I know there's been a bunch of questions on the vaccine, but on the testing side for COVID, I think Brandon asked about capacity on your kind of biologics part of the business. But on testing, you know, I think expectations are for testing to continue to ramp in the back half, certainly in the U.S., maybe globally. How are you positioned if that does occur from an ability to benefit from that capacity? You didn't quantify within your COVID contribution how much testing was of that, did you?

We did not. It is significant, and I would say a couple of things about that. One, if you look at the more prevalent testing that's going on right now, the PCR-based testing, and you consider the entire workflow, starting with sample collection to RNA extraction, purification, and ultimately through to reaction setup and the actual testing itself, we're going to be relevant at each phase of that workflow with a very broad portfolio. And so as testing has accelerated through the quarter and looking ahead at the expectation that you know, testing is going to, you know, seems to be going to be an important part of, you know, our lives going forward here. I think we are well positioned, you know, to continue to build on the position that we've got here and participate in the incremental testing that we've seen playing out.

Great. Thank you, Michael.

And that is our final question for today.

Yeah, thank you, operator, and thank you all for participating in our call today. As we close, I want to express my gratitude and admiration for all of our associates around the world who continue to live our values and work tirelessly to support our customers as they navigate the COVID-19 pandemic and seek solutions to protect, detect, and treat the virus. Our associates' passion and dedication to our mission of setting science in motion to create a better world really does position us to help bring life-changing therapies that can improve patient outcomes for people across the world. I'm optimistic about what lies ahead for our business and look forward to updating you at the end of the third quarter. Until then, take care and be well, everyone.

And that does conclude today's conference call. Thank you for your participation. You may now disconnect.