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spk02: Ladies and gentlemen, thank you for standing by, and welcome to the Avantour Third Quarter 2020 Earnings Conference Call. At this time, all participants are in 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. We ask that you please limit your question to one and one follow-up question. Please be advised that today's conference is being recorded. If you require further assistance, please press star zero. Thank you. You may begin.
spk00: Thank you, operator, and good morning, everyone. Thank you for joining us on today's call. We made the decision to accelerate the timing of our earnings release and conference call to coincide with our debt offering. We appreciate the flexibility in joining us this morning. 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 a presentation accompanying this call are available on our investor website at ir.avantourscientist.com. A replay of this webcast will be made available on our website after the call. Following our prepared remarks, we will open the line for questions. I would like to note that 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, 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'd like to turn the call over to Michael. Michael?
spk10: Thanks, Tommy. I'm starting on slide three with a brief review of Avantor's revenue profile. Avantor is uniquely positioned to offer complete solutions for many scientific workflows. We are among the most recognized and trusted global providers of products and services to the life science and advanced technology industries. And our portfolio is used in virtually every stage of the research, development, and production activities our global customers conduct. Our business model is very resilient due to our consumables-driven portfolio and highly recurring revenue base. Approximately half of our revenue comes from proprietary branded products and services, and no single customer represents more than 3% of our revenue. Approximately two-thirds of our revenue is in attractive life science and markets, including significant exposure to the bioproduction space. We're well positioned for continued growth in Europe and the Americas, and we're investing to expand our capabilities in emerging markets throughout Asia, the Middle East, and Africa. Moving to slide four, here are the third quarter business highlights. The team continues to execute extremely well in a challenging environment. We grew our top line more than 5% organically, expanded margins more than 100 basis points, increased earnings per share by more than 60 percent, and generated $266 million in free cash flow. I will cover these results in more detail on the next slide. Serving our customers and supporting them in their mission-critical work remains a top priority for us and one of our core values. Fortunately, all of our distribution, research, and manufacturing sites have remained fully operational, and we've been able to leverage our global scale and footprint to maintain supply to our customers throughout the pandemic. Bringing innovation and developing new workflow solutions is another important element of our customer-centric business model. During the third quarter, we launched multiple products to enhance our BioPharma offering, each one creating significant value to our customers. For example, we expanded our single-use portfolio with the addition of new 2D single-use bags, demonstrating our commitment to ensuring our customers have a complete range of packaging options available to meet their needs. We expanded our large-scale direct dispense packaging offerings, significantly reducing customer processing time, and minimizing contamination risk. Our Omnitop adjustable volume sterile sampling solution enables precise sample collection at very low volumes and also minimizes contamination risk, a particular benefit for our cell and gene therapy customers. We also launched JT Baker CGMP-grade IPTG, a molecular reagent used by our bioproduction customers to trigger transcription and increase protein expression. We are in the midst of commissioning our new biorepository site in Germany and expect to receive our first samples before the end of the month. With 40,000 square feet of temperature and humidity controlled space, this new facility will complement our existing biorepository and archiving capacity in Europe, enabling us to serve the growing clinical trial support needs of our bar pharma, pharma, and CRO customers. Avantor is a critical player in the COVID-19 vaccine and therapy supply chain, and we continue to collaborate closely with biopharma customers and relevant governmental authorities around the world, including representatives from Operation Warp Speed. Our 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 during this unprecedented time. We're actively supporting multiple technologies in each of the key vaccine modalities and are making the appropriate investments to increase our cleanroom and manufacturing capacity to enable us to ramp production to support commercial production of any approved vaccines. Our mission of setting science in motion to create a better world has never mattered more. Turning to slide five of the presentation, I'd like to review our financial results in more detail. Organic revenues increased 5.4%, reflecting 300 to 400 basis points of COVID-19 tailwinds, improvements in all of our end markets, and low single-digit growth of our base business. Performance was once again headlined by Biopharma, which grew by double digits in the quarter. As complexity in drug development grows and drugs increasingly become defined by the process, not the product, our comprehensive portfolio of raw materials, production technologies, and innovation capabilities position us to excel in this space. Our strong performance in the third quarter is indicative of the value we offer through our ability to collaborate directly with customers to characterize and scale up their formulations. Also, we experienced strong double-digit growth in healthcare, driven by strength in hospital and clinical reference labs. Adjusted EBITDA in the quarter was up approximately 14%, or more than 2.5 times our revenue growth, and adjusted earnings per share increased approximately 63% to 24 cents. We also continue to make good traction on tax planning and now forecast a full-year effective tax rate of 24%. We continue to generate strong free cash flow through solid operational performance and working capital discipline. We generated $266 million in the quarter, an increase of 44% compared to the same quarter last year, and are on track to generate more than $700 million in free cash flow for the full year, well above our initial full-year guidance. This will enable ongoing reduction in our net leverage to approximately four times EBITDA by year-end, down from 4.6 times at the beginning of the year. Our results reflect our attractive end-market exposure, our highly recurring revenue base, trusted and collaborative customer relationships, and our strong culture of execution enabled by the Avantor business system, which underpins everything we do. With that, let me turn it over to Tom.
spk04: Thank you, Michael, and good morning, everyone. Let's start on slide six. Organic revenues increased 5.4% in the quarter, which, as Michael mentioned, includes approximately 300 to 400 basis points of tailwinds from COVID-19-related items. Similar to the second quarter, diagnostic testing solutions drove approximately half of this benefit. with a balance equally represented by sales of personal protective equipment and biopharma production materials, including those to support vaccine and therapy development. Recalling our Q2 earnings release, we indicated an expectation for growth in July of flat to low single digit. We achieved low single digits and momentum built over the quarter. Looking at growth from a regional perspective, Americas, which represents approximately 60% of global sales, reported 4% organic revenue growth. a big improvement from the Q2 decline of nearly 7%. We experienced market improvements across all end markets, highlighted by high single-digit growth in biopharma, including double-digit growth in biopharma production, and greater than 20% growth in healthcare, driven by hospital and clinical reference lab customers, and despite continued year-over-year declines in elective procedures. The declines in education moderated significantly, although lab and school closures continue to drive overall negative growth. The government business was strong with mid-teens growth, and advanced technology and applied materials improved to roughly flat year over year. Europe, which represents approximately 35% of global sales, reported 7.2% organic revenue growth, also a big improvement from the 3% growth in the second quarter. Similar to the second quarter, biopharma grew close to 20%, which included over 40% growth in biopharma production. Healthcare improved from flattish in the second quarter to high single digit in the third quarter. Education was flat, but this actually marked a strong sequential improvement of over 1,000 basis points from the second quarter. Government grew double digits. Advanced technologies and applied materials also improved from the second quarter. Double digit declines, declining mid-single digits in the third quarter, impacted by continued industrial weakness. EMEA, representing 5% of global sales, reported a 9.4% organic revenue increase, driven by biopharma and government sales, offset by continued COVID-19 headwinds in our Indian diagnostics platform and advanced technology and applied materials end markets. Slide 7 shows our organic revenue growth by end market and product group for the quarter. Biopharma, representing approximately 50% of our revenue, experienced low teens organic revenue growth, building on the high single-digit growth in the second quarter. Strength came from our biopharma production platform, including single-use solutions, production chemicals, and personal protective equipment. Healthcare, which represents approximately 10% of our revenue, also increased double-digit organically in the third quarter. Strength was driven by new customer wins and continued COVID testing strength, offset by ongoing elective procedure weakness. Education and government, representing approximately 15 percent of our revenue, experienced mid-single-digit organic revenue decline as compared to the second quarter declines of over 20 percent. Headwinds driven by full or partial site closures at academic labs and schools have moderated, and we remain cautiously optimistic on improvements for the balance of the year. Advanced technologies and applied materials, representing approximately 25 percent of our revenue, experienced low single-digit organic revenue decline as compared to the second quarter mid-single-digit declines. Modest sequential improvements were experienced in our Americas defense, Europe microelectronics, and global food and beverage businesses. By product group, proprietary materials and consumables experienced double-digit growth, with strength in the Americas and EMEA. Services and specialty procurement increased high single digits driven by ongoing clinical services strength, and improved equipment services as customer sites continued to reopen. Equipment and instrumentation were down mid-single digits, reflecting ongoing CapEx investment declines. However, these declines are moderating, and we actually improved over 15% from the second quarter to the third quarter. Looking ahead to October, we expect organic revenues to be up approximately mid- to high-single digits. However, we are cautious projecting these October trends over the full quarter, given the ongoing limited forward visibility and uncertainty in the macro environment. Our biopharma momentum is expected to continue. In the education and government end market, we forecast modest improvements as lab sites continue to gradually reopen. In healthcare, COVID-related tailwinds should continue and offset the adverse impact from elective procedure weakness. Finally, our advanced technologies and applied materials business is expected to experience modest fourth quarter declines. Turning to slide eight, let me start with our third quarter adjusted EBITDA. We achieved approximately 14 percent growth in adjusted EBITDA and 112 basis points of margin expansion. Key drivers of the performance were commercial excellence, volume growth, favorable mix including strong growth in biopharma production and proprietary offerings, and continued discretionary cost containment, all offset by material inflation. While the factors driving strong adjusted EBITDA margin expansion year to date are expected to continue, we are facing a difficult prior year comparison in the fourth quarter of 2019 of 130 basis points of margin expansion. Consequently, the fourth quarter 2020 margin expansion may be more moderate compared to the 80 basis points of expansion we have driven through the first three quarters of the year. Free cash flow continues to be strong with $266 million in the third quarter reflecting stronger adjusted EBITDA, better working capital performance, and lower tax payments, offset by the unfavorable timing of interest payments, which will be an upside to our fourth quarter cash flows. Normalizing this timing, free cash flow would have been $319 million. Year-to-date free cash flow generation stands at $582 million, and we are now on track to achieve free cash flow exceeding $700 million in 2020. Finally, we achieved approximately 63% 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 refinancing, and the improvement in our income tax rate. We continue to make progress with respect to income tax planning and now expect a full-year effective tax rate of approximately 24%. Year-to-date for 2020, we grew our adjusted earnings per share approximately 53%, to $0.60 per share. Slide 9 has our segment results. Americas reported 21.4% in adjusted EBITDA margin rate, a 152 basis point improvement as compared to the third quarter of 2019. Key drivers include commercial excellence, volume growth, favorable mix driven by a higher proportion of growth in proprietary materials and consumables, productivity, and strong discretionary cost containment. Year-to-date 2020 adjusted EBITDA margin expanded 173 basis points in the Americas. Europe reported 17.5% in adjusted EBITDA margin rate, a 73 basis point improvement as compared to the third quarter of 2019. Key drivers include commercial excellence, volume growth, productivity, and strong discretionary cost containment, offsetting unfavorable mix and inflation. Year-to-date 2020 adjusted EBITDA margin has expanded 76 basis points. EMEA reported 22.7% in adjusted EBITDA margin rate, a 380 basis point improvement as compared to the third quarter of 2019. Key drivers include volume growth, better supply chain performance, and strong discretionary cost containment. Year-to-date 2020 adjusted EBITDA margin expanded 88 basis points for EMEA. This concludes my prepared remarks. I'll now hand it back over to Michael.
spk10: Thanks, Tom. I'm on slide 10. We executed well in a challenging environment, and our top-line performance, strong EBITDA, and adjusted earnings per share and outstanding cash generation reflect the resiliency of our business model, 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, our business remains strong, and we are committed to our role in combating COVID-19 by supporting our customers' ongoing initiatives in testing, vaccine and therapy development, and ultimately the production of approved treatments. Reflecting our relevance in this critical endeavor, our bioproduction order book has more than doubled, and we are actively investing to capture this opportunity. The potential to achieve life sciences breakthroughs has never been greater. We remain steadfast in our focus on executing our long-term growth strategy and are optimistic about our future. I want to thank you for your interest and investment in Invantor and for your ongoing support. I will now turn it over to the operator to begin the question and answer portion of our call.
spk02: If you would like to ask an audio question, please press star 1 on your telephone keypad. Again, that's star 1 to ask an audio question. We ask that you please limit your question to one and one follow-up. Our first question comes from the line of Tycho Peterson with JP Morgan.
spk01: Hey, good morning. Michael, I'm just wondering if you could comment on why the COVID tailwinds moderated this quarter relative to last quarter. Is that just the timing of some of the vaccine campaigns? And, you know, should we assume that three-quarters of it was testing in PPE like it was last quarter, or was there any mix-shift there?
spk10: Yeah, good morning, Tycho. Thanks for joining the call today. As we mentioned in Tom's remarks, roughly half of the tailwinds are linked to testing. And I think as we'd said earlier in the quarter, we saw somewhat of a moderation in testing in the early part of the summer, particularly in July and August. And we saw an acceleration back in September. But on a full quarter basis, testing tailwinds for us were somewhat moderated relative to what we saw in the second quarter. Similar dynamic for PPE, where the tailwind wasn't quite as strong. A piece of that is the continued supply constraints that certain elements of that portfolio continue to endure. And for us, the acceleration on the vaccine piece really won't come in a meaningful way until there's an approved treatment. We've been supporting the process developments and the clinical trials, but, you know, you're talking, you know, tens of thousands of doses at that scale. And as we look forward, you know, to an eventual approval, you know, you're obviously then moving into the millions and presumably billions of doses. So the tailwinds will shift. as we, you know, move into a phase of an approved, you know, treatment.
spk01: And then on the end markets, you know, on biopharma, obviously great strength there. You talked a lot about bioprocess. Can you talk on the R&D side, the biopharma R&D piece that's still 30-year revenues? And, you know, any thoughts on four-cube budget flush? We've heard some of your peers kind of talk that down. And I know overall equipment was down mid-single digits, so is there any hope equipment could recover in the fourth quarter?
spk10: We don't have a lot of visibility. We were encouraged, you know, as we saw equipment, you know, kind of accelerate maybe 15% in the third quarter relative to the second quarter, but still off, you know, meaningfully. And, you know, we don't have a long, you know, window into the order book for that equipment. You know, you're correct to point out at the end of the year, you would typically see some you know, potential budget flush. Remind you, last year, we didn't really experience much in the way of a budget flush the last couple of weeks of the year. And, you know, the visibility's, you know, further pampered this go-around just given the pandemic. But what I can say about the R&D environment, you know, we've seen that, you know, steadily improve throughout the third quarter. And, Even as we move into October here, as Tom indicated, the business is up overall, mid to high single digits in the month of October. And certainly, part of that acceleration that we do see is coming from the R&D space in biopharma. It does appear to be improving sequentially.
spk01: Okay, and then last one before I hop off on health care, you had a huge sequential swing there. How much of that was recapture of any delays out of the second quarter and any additional thoughts into the fourth quarter?
spk10: Yeah, a lot of momentum in the health care space. As you point out, we were well into the double digits from a growth standpoint. Strong recovery in both the reference labs that we serviced And a return of obviously not just the COVID testing, but many of those labs that we support don't have a lot of exposure to COVID. And you're seeing a return of kind of a more normalized procedure environment and then associated diagnostics that come with that. We were also successful in the quarter leveraging our supply chain. you know, to pick up, you know, business that we hadn't enjoyed before and, you know, customers, you know, really benefiting from the security that our supply chain provides to, you know, keep them, you know, supplied in a pretty critical time. So certainly a piece of that is a reflection of new business wins that we had throughout the quarter.
spk04: And then all that, Tycho, and all that delivered with still, you know, a fairly tempered environment on elective procedures. So, we're looking forward to, you know, the eventual, you know, improvement of that as well.
spk03: Great. Thanks for the call. Thanks, Michael.
spk02: Your next question comes from the line of BJ Kumar with Evercore ISI.
spk03: Hey, guys. Thanks for taking the question, and congrats on a good print here. Michael, maybe on the comment on bioproduction order book has doubled, what was the base? Is that a year-on-year doubling up or sequential doubling up? And what does it mean for, I guess, from a top-line perspective or perhaps contribution to top-line when you think about 2021? Yeah, good morning, Vijay.
spk10: Good to hear from you. The Board of Books has doubled since the beginning of the year, and we've really seen an acceleration of that book as we've moved through the second quarter and into the third quarter, and it's even continued to build here as we've gone through the early days of the fourth quarter. And it reflects a couple of things. Firstly, the base business that we support, absent the vaccine effect, is extremely robust. We've been investing heavily over the last several years in new product capabilities and innovation capabilities. We've had tremendous success in moving our technologies through the pipeline. You see that reflected in the base business. Encouragingly, the majority of this order book build is actually in our base business. you know, in the last quarter, you know, we are starting to see, you know, COVID, you know, driven vaccine orders coming into the book. And that, you know, will certainly satisfy some of that in the fourth quarter as, you know, any of these vaccines, you know, move from clinical trial into, you know, an approval phase and into commercial production. But I would anticipate more of that coming, you know, next year, you know, just given where we're at here in the quarter and the fact that there isn't an approved vaccine but ultimately you know the visibility in terms of you know what it could mean for us you know next year is still you know pretty foggy BJ I think a couple things I would point out one we're going to be relevant across all of the major modalities that are being you know developed whether that be mRNA or recombinant proteins viral vectors so that's the first point the ten point There's a lot of variables that will ultimately dictate what this means for us specifically. We've tried to articulate what we think this does from an addressable market standpoint by technology. But it's obviously influenced by things like the number of doses that are ultimately produced, the mix of technologies that are ultimately approved here. And then I think an important variable here is what's going to be the adoption rate of any of the vaccines that are on the market. I think the data on that is somewhat mixed at the moment. So it makes it difficult for us to give you a real specific range on what level of revenue we would build into a forward plan. There's obviously lots of different scenarios as they play out. I think the key takeaway for us is we do see considerable opportunity here. We have mobilized to meet that demand through investments in capacity to ensure that we can fulfill the orders as they come. I think we're obviously very encouraged about the trend here.
spk04: And Vijay, on the open orders, a couple of things I would add is that The mix between, and Michael mentioned that the COVID piece is fairly small, but the mix between our single use and our high purity chemicals is roughly split, equal. The other thing is that most of this is customized. So this is offerings that are non-cancellable. We have commitment from the customers and we've done engineering and formulations work with them. So it's pretty firm and like Michael said, it continues to track upward in the fourth quarter.
spk03: That's helpful, guys. And Tom, one on the free cash flows here. I mean, if I recollect the start of the year, we started, I think, sub-600. I mean, this is, I'm just curious, about $700 million for the year That's really strong. Was there any timing impact? And how should we think about these free cash flows? Should free cash flows be growing off of this new base? And what's the primary use? If it's debt refi, I did see the refi announcement this morning. Perhaps any color on what that would mean for interest expense going forward.
spk04: Yeah, sure. So just on the free cash flow itself, Vijay, just to – I remind everybody, we started the year with an expectation of 450 to 500 million in free cash flow. We are already at 582 million through the third quarter. The only unusual thing that's in there apart from the benefit from the refinancing that we've done. And that's basically a forward benefit, not a ton that's come through yet, because we actually had to accelerate some interest payments into the third quarter that normally would be paid in the fourth quarter to the tune of about $60 million that we were able to overcome and still deliver that $582 million. But the only unusual item really in there is part of the CARES Act, we were able to defer some tax payments and some employer tax liabilities, but that's, you know, less than $50 million. So, I mean, the real benefit is in working capital. We've been able to contain working capital to just about flat through three quarters, you know, despite the growth that we've delivered. In fact, in the third quarter, we actually reduced working capital by close to $20 million, and yet, you know, we, you know, grew sales, as you saw, 5.5% or so. So that's, you know, I think mostly reflective of operational. I think going forward, I think the refinancing that we've done will be helpful. As you're aware, and just to give everybody an update on the financing process because, you know, I'm sure we'll get questions on it, we have about $5 billion of debt outstanding. We refinanced two of that five in July. As you know, we reduced the rate. on those borrowings from 9% to about 4.5%. And that's going to be close to $90 million of annual pre-tax savings. As I said, that starts to kick in in earnest in the fourth quarter. On the remaining $3 billion of secure, we're pretty happy with a billion of it. That's in our term loans. We repriced that in February. That's at... Below what today's market is, it's about library plus 225. So there's no prepayment penalty, and we prefer to keep that one in place. The remaining $2 billion of that secured is bond financing. It's got an effective rate, if you look at the two tranches, of about five and three quarters. We believe we can do much better than that, given the continued improvement in our capital structure. our debt rating, our cash flows, and so forth. We expect to refinance it with a combination of term loans and with bonds. We launched the term loan process on Friday. And at the time, it was pretty clear we were also going to do a bond process because the sources and uses we articulated had more uses than sources. And that came clear this morning when we announced the bond as well. So, the term loan process normally takes a week. That's why we started last Friday. The bond process is a bit faster. And by the way, that's why we accelerated the earnings release. We want to have all the information on Q3 out there for as long as possible. So all in, I expect to see the pricing on that $2 billion by the end of the week. I will say the market has turned a little bit choppy since we launched, as you know, but we're dealing from a position of strength. We've got no requirement whatsoever to accept anything that would be suboptimal. The investor interest so far is strong. We've got a book building in the term loan. We expect to have a decision point at the end of the week. You can kind of do the math on the 5.75, you know, on the $2 billion. But, you know, if you can reduce that to, you know, effectively, you know, 300 or sorry, 3% or so, that would be meaningful savings. So we'll update everybody once we're through the process.
spk03: Thank you.
spk02: Your next question comes from the line of Patrick Donnelly with Citi.
spk09: Great, thanks guys. Maybe just to follow up on one of Vijay's there. On the bioproduction book doubling, are you able to talk about the magnitude there in terms of hard numbers? We had a couple of your peers give hard numbers there and talk about what percent is going to burn in 2019 versus, sorry, 2020 versus 21. So wondering, again, just the raw size there, if you're able to talk about it. And then, Michael, maybe just a little more color in terms of how you see it trending once these vaccines flip commercial. Does the revenue really take off there from the book?
spk10: Yeah. Thanks for the question. Good to hear from you. I mean, look, there's a lot of momentum here in the order book, obviously, with vaccines. the numbers that we've talked about. Typically in this order book, we would see a couple of months ahead. One of the elements of this is we're starting to see, at least in this part of the business, an order book that's now lengthened well into next year. As we sit here today, we probably have an order book that would back, you know, roughly half of a full year's, you know, demand or revenue in that, you know, part of the business. So it is obviously very, very meaningful. Relative to, you know, what it looks like on the back end of a vaccine, I'll just take you back to the various factors here that will dictate that, you know, which, you know, which mix of technologies ultimately get approved. As you know, the raw material requirements are greatly different depending on which of the four modalities ultimately prevail here or which mix of modalities. I think it's our view there will probably be more than one approval coming through here. And then how quickly our customers can ramp production is going to be a major driver of how quickly that they start pulling on our materials. And then lastly, again, I'll point out it's one thing to have the capacity and approval, but it's you know, the society can adopt these vaccines and how quickly will they adopt and ultimately dictate that. But, you know, we're investing as if, you know, there'll be a pretty rapid ramp once there are approvals. And as Tom mentioned, you know, at some level we're already starting to see and fulfill orders, you know, that are obviously, you know, moving from clinical trial to kind of production at risk here. And given the lead time on these materials and the customized nature of these materials, you know, the orders that we're getting at this point for, you know, delivery, you know, later this year or into the first quarter, you know, would be firm at this point given the commitments that we have to make on those. So we'll continue to follow it closely and, you know, obviously as... approvals on any vaccines, you know, get issued, you know, we'll respond accordingly.
spk09: That's helpful, Michael. Thanks. And maybe, Tom, just on the margin expansion side, obviously been pretty compelling here year to date, great quarter here. As you look ahead to some of those tailwinds we just talked about in the bioproduction book, how should we think about the margin profile of that revenue? Again, it feels like it's that inflex higher it should carry. higher margin profile than the core business, but just wondering if we're thinking about that right, if you could just talk about the margin profile.
spk04: Yeah, absolutely. From a longer-term perspective, Patrick, as you know, we've endeavored to grow our EBITDA margin at a rate of 1.5 to 2 times the sales growth rate. So if sales is growing 5%, we expect at least to be growing 7.5 on the EBITDA side, if not 10. The big variable between the two would be mixed. You're right, the biopharma production business does have a more attractive margin profile than some of the other parts of the portfolio. Our gross margin is roughly 31%, 32%. I'm not saying this is double, but it is meaningfully accretive to that 31% to 32%. We'll be planning 2021 with those open orders in mind. I do want to remind everybody, from a shorter-term perspective, we had a really outsized margin growth in the fourth quarter of last year, 130 basis points, as I said. As some of these better-mixed products start to come through, we'll see that longer-term impact. Hopefully, if we start to see it in the fourth quarter, maybe we can offset some of these Overall, I think we'll finish very, very strong and attractive margin profiles to point out for first quarter and beyond. That sounds good. Thanks, Tom.
spk02: Your next question comes from the line of Deb Schenkel with Cowan.
spk07: Hi, this is Ryan Archer, Doug. Thanks for taking my questions. Good morning. Good morning. Maybe starting on Europe, can you talk about customer activity levels across the core business in Europe early in Q4? Have you seen any pause in the pace of improvement recently due to COVID flare-ups, or do you expect continued improvement in activity moving forward?
spk10: Europe has been a bright spot for us all year, and you saw that again in our third quarter numbers with more than 7% growth. The team's done an amazing job out there meeting really strong demand, obviously, and supplementing the portfolio with with new products and solutions. We've launched more than 90,000 products this year, many of those to supplement a lot of these COVID workflows that we're addressing. And you see that being reflected in what the team in Europe has been able to deliver this year. As we moved into or through the third quarter, probably one of the bigger changes that we saw was a return of the academic sector. I think in Tom's remarks, he referenced maybe 1,000-point improvement in the performance of that part of the business and kind of returned to somewhat flattish, if you will. Momentum continues into the fourth quarter here. Europe is off to another very strong start here in the first month of the quarter. But we are aware, obviously, as we're in whatever wave of the pandemic we're We want to refer to this as there's obviously a lot of concern across continental Europe regarding the spread of the pandemic. And we're aware that certain countries have instituted more lockdown-type measures. I was on the phone with the team this morning to understand where things are at at the moment. I think this is a general trend we see playing out in the US as well, where there seems to be limited appetite to go back to the extreme lockdown measures that were put in place back in March and April. I think they're doing prudent things around masks and limiting crowd size at restaurants and bars and gyms and such. But universities continue to remain open. And, you know, I think from where we see at the moment, you know, we're not anticipating, as we sit here today, you know, a rollback of the performance that we've, you know, experienced in the third quarter.
spk07: Got it. And then maybe just to follow up on bioproduction more explicitly. So revenue up 40% in the quarter or is up greater than 100%. you know, given you haven't had any meaningful contributions from vaccines yet and given the significant scale-up expected in vaccine production over the next 12 months, do you expect bioproduction revenue growth to at least be sustained at the current 40% level in 2021 or could it accelerate even faster in 2021?
spk10: You know, that platform for us has been growing, well, BioPharma as an end market for us has been growing, you know, high single digits for, you know, the better part of the last couple of years and that you know, strong growth in the R&D, you know, portion of that business. And then, you know, the other third of that platform is our production offering, which has been growing, you know, double digits, you know, over the last several years. And we certainly see, you know, that momentum continuing absent, you know, even any impact from the vaccine. The vaccine will obviously only work to accelerate that growth to the extent that it, you know, we do see approvals and an adoption and ultimately a ramp up here. You know, hard to say what the ceiling on that is going to be, you know, given the variables that I've already described here. But, you know, we're confident, you know, absent vaccines and continued double-digit growth of that bioproduction platform and, you know, certainly will be, you know, favorably impacted by any approvals that come through.
spk07: Okay. And if I could sneak one more in. Can you talk a bit about your exposure to rapid antigen testing within those COVID diagnostic tailwinds, and how meaningful that could be for a mantle over the next few quarters as manufacturing of those tests begins to meaningfully scale? Have you seen any benefit from rapid antigen tests to date, or is that largely incremental to your COVID diagnostic tailwinds over the next couple quarters? Thank you.
spk10: Yeah, it's a great question. You know, in the third quarter results, very limited, you know, impact from the antigen-based testing. But we are starting to see some upside from that in the early days of the fourth quarter here. Just maybe take a step back and remind the group here on our exposure to testing broadly. I think we've all become experts in the three types of tests that are out there. You have the two versions of antigen-based testing, the molecular you know, PCR testing, which continues to be the gold standard. You know, for us to date has probably been, you know, the platform that has driven the most tailwinds. We're very well, you know, positioned to support the sample prep workflow that precedes the actual, you know, test itself. And, you know, that has been strong, and we see that continuing. You know, the other test that you're referring to is these more rapid antigen-based tests. We will play that platform really as a supply chain solution. We've got access to certain approved tests that we will source from our third-party partners, and we will distribute those into the marketplace. We have quite a meaningful order book that's developing here for the fourth quarter on that piece of the testing workflow. And then the last element of the testing capabilities is in the serological tests where we have both content that we provide to OEM manufacturers as well as access to tests themselves. I think the upside was expected to be stronger than it has been to date, and I think that tracks the relatively muted adoption that we've seen around the world for those tests. As we look forward, I think I'd summarize it by saying continued momentum and tailwinds associated with PCR testing, and at least in the early days of the fourth quarter here, we are encouraged by the uptake of some of these antigen-based tests.
spk02: Your next question comes from the line of Michael Riskin with Bank of America.
spk05: Hey, thanks. This is Mike on for Derek. I want to go back to some of the underlying 3Q performance, sort of looking at the landscape ex-COVID. I think we were just expecting a little bit stronger performance in the quarter given the easy comps you had year over year. I think 3Q19 was one of the easiest comps you've seen all year. So I was just wondering if you could go deeper into the sequential improvement in the base business if you sort of look at it on an adjusted basis. and how that brings your thinking as you go forward into 4Q, because, again, you get a little bit of a tougher comp, 3Q to 4Q, ex-COVID.
spk10: Yeah, good morning. Thanks for the question. If you look at the performance in the second quarter maybe as a starting point, you know, we saw roughly 700 to 800 basis point decline in our base business, and then we were aided by, you know, roughly 500 to 600 basis points of COVID tailwinds. So as kind of an anchoring point for you, the base business from second quarter to third quarter improved sequentially by nearly 1,000 basis points. So when I read through all the numbers here, obviously we're excited by the overall growth and margin expansion and cash flow. But one of the things that's most encouraging to me is to see the base business growing low single digits in the quarter, unaided by, obviously, any of these tailwinds as you described. And if you look at it from an end market perspective, biopharma, 50% of the revenue, very, very strong performance in the quarter. And I would say we saw a sequential improvement in the capacity utilization in the R&D space, and we've seen that carry into the fourth quarter. In the education and government part of our business, the government piece has been strong second quarter and third quarter, driven by a lot of the COVID programs that we've been supporting. But the education piece has probably been one of the pieces of our portfolio that has been, you know, hit the most. You know, that business was down 50% in the early days of the second quarter and, you know, have, you know, recovered substantially in the third quarter. You know, it was roughly flat in Europe. We were down mid to high single digits on that platform in the Americas. And, you know, so there's still a bit of recovery to come there and, That's ultimately going to take a full reopening of all the campuses as well as a reopening of the K-12 schools across the U.S. Healthcare obviously continues to be a big bright spot for us. We've seen a nice recovery in our reference labs business, an acceleration in the hospital portion of that business, but we still have headwinds. in the, you know, elective procedure-driven part of our business, particularly in our biomaterials, you know, business, which, you know, we don't really anticipate much recovery in that business here in the fourth quarter. And, you know, hopefully I think, you know, that's probably more of a 2021 event. So still, you know, I think some headroom to go there on that piece of the business. And then, you know, in the applied part of our business, you know, roughly half of that is going to be rather you know, defensive-oriented and, you know, not necessarily subject to some of the macro shocks that we've seen. That piece of the business has held up, you know, very well. The other part of the business, which is roughly 10% and more linked to PMI, we've seen that, you know, some sequential recovery as PMIs have moved above 50 in the recent quarter. It's, you know, still down, you know, modestly for us, low single digits, but, you know, obviously has held up well. So that's a little how we see the you know, the end markets. And as we move into the fourth quarter, obviously we ended the third quarter with some nice momentum and, you know, seems to have carried into the month of October.
spk05: Great. Thanks. And a quick follow-up from me on the free cash flow and the debt refinance. If you look at the debt you did earlier this year, what you've got going on now, and the strong free cash flow year to date, the debt burden is certainly a lot lighter than you would have thought maybe six months or a year ago. I recognize you've still got the long-term targets of two to four times leverage, but more in the near term, does this give you a little bit more flexibility to go out and do something, or is that still getting a little bit ahead of ourselves? Do you want to get it down further before you start getting active again?
spk04: Great question, Michael. This is Tom. Yeah, I think you're right on point there. I mean, what we've said all along since the IPO is that we wanted to be comfortably operating within two to four times leverage. We started out in 2019 north of seven, so we've worked that down to the 4.2 that we have today. We do expect to be at or beneath four by the end of the year, given the strength and the business performance. That's not a magical point for us, though, from an M&A perspective. We actually started our program up at the beginning of this year. We brought in a leader. Mark Centrality has been working with each of our global business units to not only develop the pipeline but understand the strategy and help them with their strategy and link that with what are the opportunities that are out there. So we've actually participated in a couple of projects. we're anxious to get rolling. I would expect that in the near term, probably next six months or so, you wouldn't see us do anything but sort of tuck in, maybe for the next year, tuck in type acquisitions, which would be maybe 1% to 2% of revenue, looking to round out some of the workflow positions in places like biopharma production or in our lab offerings. And then going forward, who knows? I mean, we're looking at a broad funnel of things that might not even be available today. But we're really trying to focus on our core businesses. And so you would kind of expect us to be doing deals that are more of a tuck-in or a little bit larger variety than, say, a massive transformational deal. That's the way we're looking at it.
spk05: That's really helpful. Thanks so much, guys.
spk02: Your next question comes from the line of Brandon Coolard with Jefferies.
spk08: Hey, thanks. Good morning. Just a two-part question for you, Tom. Looking through the queue, looks like there was about a 70 basis point inventory charge in the gross margin line in the third quarter. Is that a one-time dynamic? Any goalposts you can kind of share with us as far as kind of your gross margin outlook for the fourth quarter. And then nice progress on the tax rate. Just curious to what extent you might see more room to bring that down even further into the low 20s near the midterm.
spk04: Yeah, great questions, Brandon. Let me take the first one. We have a number of initiatives that are driving gross margin improvement. We've got really good management of the price versus cost inflation dynamic. We've had favorable mix, as we've talked about, with proprietary growth, you know, driving better margin rates. And then the productivity and cost containment, you know, initiatives that we've got, including, you know, in this COVID environment. I mean, obviously, discretionary spend has been, you know, a pretty important area of focus. Our year-to-date gross margins are up 70 base points. We went from, you know, 31.9 to 32.6. However, as you point out, the third quarter gross margin rate was a little bit less than that. The drivers that I mentioned, so the price, the mix, the productivity, all were in place, but we did have a couple of non-recurring, non-cash adjustments in the quarter. One was LIFO related. We follow LIFO accounting for our inventory of the Americas, and we had to make some adjustments to reflect the inflation we're experiencing in certain inventory areas. In personal protective equipment in particular, there's been unprecedented demand that is basically overwhelming the supply, which is leading to abnormally high inflation in purchased materials, things like gloves and apparel. the coffee goods sold at the current prices and leave in inventory the older prices. That's just a dynamic of LIFO in an inflationary accounting environment. The second point, we had some cleanup in some distribution inventories that have gotten behind us. For both of these things, I don't expect them to have any impact Thanks.
spk02: Your next question comes from the line of Dan Brennan with UBS.
spk04: Hey, Dan. Dan, before I get to your question, I didn't get to point two on Brandon's question on the tax rate. I apologize for that. Yeah, so you go back in time at the start of pre-IPO. We were at around a 30, north of 30% adjusted tax rate. And we had articulated a plan to work that to the mid-20s through the removal of some inefficiencies in the way we've financed some of our businesses internationally. We're largely through those efforts. And as you've seen, our tax rate is down to, for the full year, we're now expecting roughly a 24% tax rate, which is, better than the lower end of the guidance that we had provided at the beginning of the year. So good progress there. Yes, there is more opportunity, in particular in the way we operate our businesses in places like Central Europe and the whole European continent. And so we've got some longer lead time initiatives that are underway that we think can continue to drive that you know, that rate down. I'd like to be, you know, approaching 20, you know, with the implementation of these initiatives. They're probably going to take, you know, a year or two to get into place. So I wouldn't factor them into, you know, your short-term modeling. But, you know, the traction has been pretty good as has the, you know, the work on the tax rate or, sorry, the cash tax part itself. So overall, you know, Thinking like you are, we've got to continue with this. The one wild card is the election and how that impacts tax planning and tax rates for all of us.
spk06: Thanks. Great, thanks. Sure. Maybe just one question on the Q4 comments, the mid-single, high-single. Did you give a sense, or the October comments, did you break that down between what would be implied for COVID versus debates in that?
spk04: No, we do not. And I would expect that, as Michael said, the mix of the COVID tailwinds can have some variability to it. The second quarter was really strong for a lot of the some benefit from the serological testing in the second quarter that contributed to the 500 to 600 basis points. As you look at the third quarter, the serological pieces fell off a bit just because of the mix and what the market is using. By the same token, the overall testing volumes have increased as we head into the fourth quarter. We saw some good orders activity in the more on the diagnostic side. The biopharma production piece of it has been really strong. So it's hard to say what the exact precise tailwinds would be, but I would expect somewhere in the Q2 to Q3 kind of range, somewhere in those dynamics.
spk06: Great. Thank you for that. And then I know there's been a series of questions on obviously your competitive positioning and the vaccine and therapeutic opportunity. But I was hoping one more follow-up there, since you guys did provide a pretty extensive analysis on sizing the opportunity across the different modalities. So it sounds like that part of your business maybe is, you know, was maybe 50 bits or so in Q3, just doing some quick math. I mean, is it, granted there's a range of outcomes, a wide range of outcomes in 21, but certainly with the order book that you see, I would think there's a way to maybe frame What could be, you know, kind of a range of outlook for 21 based upon the different modalities? So, anyway, one more shot just given the extensive analysis that you've done and the importance of it to your business. I was just wondering if there's another way for us to think through, you know, maybe what a range of outcomes could look like going forward. Thanks.
spk10: Yeah, thanks for the question. Certainly can empathize with your interest in trying to understand what this could mean for the business. And believe us, we're spending a tremendous amount of time trying to model that and really reflect that in the investments that we're making to ensure that we can maximize the opportunity here. I think the best way that we've found so far to kind of describe the potential impact to the business is take it back to the impact on addressable markets. So I remind you, we participate in our bioproduction business in a market that's roughly $10 million based on the technologies that we have in our portfolio. And depending on or based on the vaccine candidates that are in the pipeline and the projected doses based on publicly available information on what could be produced from each of those candidates. And then looking at the raw material requirements for those and single use requirements for those technologies You know, we think that this could increase our addressable market anywhere from, you know, call it, you know, $4 to $5 billion on the low end up to $8 or $9 billion on the high end. So you can see, you know, it's a pretty big range of outcomes, but at least on a minimum, we anticipated having a pretty marked impact on the addressable market for our business.
spk02: Ladies and gentlemen, we see a lot of time for questions. I would now like to turn the conference over to Michael Stubblefield for any additional or closing remarks.
spk10: Thank you, Operator, and thank you all again for participating in our call today and for being flexible with the late shift in the timing of the call. As we close, I just wanted to express my continued gratitude and admiration for all of our global associates who are actively living our values every day and working tirelessly to support all of our global customers during this unprecedented time. You know, truly it's an inspiration and a passion and a dedication to our mission of setting science in motion to create a better world that has never mattered more. I'm truly excited about what lies ahead for a long tour and looking forward to updating you at the end of the fourth quarter. And until then, take care and be well, everyone. Thank you.
spk02: Thank you for participating in today's conference call. You may now disconnect your lines at this time.
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