Avantor, Inc. (AVTR) Q1 2022 Earnings Report, Transcript and Summary

Good morning. My name is Katie, and I will be your conference operator today. At this time, I would like to welcome everyone to Avantor's First Quarter 2022 Earnings Results Conference Call. [Operator Instructions] I'd now like to hand the call over to Tommy Thomas, Vice President of Investor Relations. Mr. Thomas, you may begin the conference.

Good morning. Thank you for joining us today. Our speakers today are Michael Stubblefield, President and Chief Executive Officer; and Tom Szlosek, Executive Vice President and Chief Financial Officer. The press release and our presentation accompanying this call are available on our Investor Relations website at ir.avantorsciences.com. A replay of this webcast will also be made available on our website after the call. Following our prepared remarks, we will open the line for questions. During this call, we will be making some forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings. Actual results might differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of the date that they are made. We do not assume any obligation to update these forward-looking statements whether as 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 turn the call over to Michael. Michael?

Thanks, Tommy, and good morning, everyone. I appreciate you joining us today. I'm starting on Slide 3. As you have hopefully seen in the press release we issued last night with our first quarter results, we started the year with another outstanding quarter. Our strong results across all key financial metrics, including revenue growth, margin expansion, earnings growth and free cash flow generation, highlight our premium position in attractive end markets, our compelling product and service offerings, the resiliency of our business model in a dynamic macro environment and our continued track record of execution. In the first quarter, we achieved 7.3% core organic revenue growth driven by continued momentum across our life sciences platform as well as in our applied end markets. We expanded EBITDA margins by approximately 140 basis points, including the favorable impact of our 2021 acquisitions and expansion in our core business despite intensifying inflationary pressures. We increased adjusted net income by approximately 15% and generated approximately $128 million of free cash flow. We also made significant progress in executing our long-term growth strategy. We continue to invest in capacity and infrastructure to support our growth and currently have more than 2 dozen manufacturing expansion projects in flight, 5 of which were completed in the first quarter. Our 2021 acquisitions delivered strong core growth and margins ahead of our internal operating plan, and we are pleased with our progress on integration including commercial synergies. Tom will provide additional M&A color later in the presentation. We remain focused on helping scientists realize the potential of new breakthroughs and introduced several new proprietary products in the first quarter. We launched multiple offerings targeting the cell and gene therapy market, including our proprietary cell lysis solution for use in adeno-associated viral vector production and a reagent used to remove closed cell DNA and RNA impurities. We also executed a partnership agreement that will enable us to offer custom cGMP plasma DNA for viral vector, mRNA and nucleic acid workflows. To expand our offering in the LC-MS analytical workflow, we also launched a new line of J.T.Baker analytical syringe filters. Additionally, we introduced new products in our formulated silicone platform, including a proprietary formulation for novel in situ surgical applications and a thermal management solution for electronic applications. Looking ahead, we have good momentum in our end markets. Our order book is growing, and we continue to leverage the Avantor Business System to drive execution in a challenging operating environment. We will continue to progress the integration of our recent acquisitions and are actively working our M&A pipeline. We remain confident in delivering another great year with strong growth and robust margin expansion, enabling us to raise our EPS guidance for the full year. Moving on to Slide 4. I'd like to touch on some macro factors impacting our space. I'm starting on the left with concerns regarding the strength of the global economy. Encouragingly, the vast majority of the end markets we serve are growing mid- to high single digits. Fueled by continued strength of the core monoclonal antibody workflow and the emerging modalities of cell and gene therapy and mRNA, biopharma activity in both R&D and production remains high. Core health care continues to expand, and growth in our advanced technology and applied materials business accelerated quarter-over-quarter. Within our applied platforms, we have exposure to many different end markets including semiconductors, chemicals, energy and food and beverage, and we are not seeing any signs of slowdown. Demand patterns in each of the 3 regions we serve are also holding up well, and we continue to benefit from our unparalleled customer access and a resilient, highly recurring revenue model. The geopolitical situation in Russia and Ukraine remains volatile, and our hearts are with those affected by this tragic conflict. We have ceased all sales to Russia, which historically have averaged about $5 million per year and do not have any cash or working capital exposure. In keeping with our values, we donated nearly $1.2 million in gloves and masks, and we are working with our associates throughout Europe to collect critical items such as food, blankets and clothing to donate to Ukraine refugees. Moving to COVID. The situation continues to evolve, and we are encouraged to see sustained declines in severe infections and deaths. Our COVID-related offerings, including personal protective equipment, diagnostic testing kits and vaccine content represent less than 3% of our total revenue. And the strength of our core business will more than offset the 2% to 3% headwinds we anticipate in 2022. Additionally, the fungibility of our bioproduction capacity to support both COVID-19 vaccines and therapeutics as well as our core business give us flexibility to offset any incremental headwinds created from a transition to an endemic phase. Also, the ongoing lockdowns in Shanghai have had limited impact on our business given our relatively modest exposure to the region. Not surprisingly, we are facing historically high levels of inflation in virtually all of our cost categories. Nevertheless, our organic margin expansion in the first quarter is a proof point of our ability to manage through this cycle leveraging the Avantor Business System to drive commercial excellence and productivity initiatives. Industry-wide supply constraints, including the supply of raw materials and ongoing transportation delays, have been part of our reality since the onset of the pandemic. Consistent execution and managing a complex supply chain are part of our DNA, and we are confident in our ability to mitigate further challenges. In addition to leveraging the ongoing benefits associated with our global footprint, we have undertaken several initiatives to ensure that we can continue to meet our customers' expectations. We are increasing our manufacturing and distribution capacity throughout our network. We recently approved additional investments on our Phillipsburg site that will nearly double our global capacity for salts, and we are adding cGMP manufacturing capacity in Singapore to serve biopharma customers in the EMEA region. We are expanding supply chain operations headcount globally and increasing recruiting and retention activities accordingly. Finally, we continue to fortify our inventory levels, broaden our supplier partnerships and optimize our transportation network to ensure that we can supply the products our customers need to continue their scientific work. A final point to mention is the rising interest rate environment. Despite the expectation of rising rates, our debt financing strategy has enabled us to confirm our original 2022 interest expense estimate, and we are well positioned against future rate increases given limited maturities over the next 5 years and the expectation of ongoing deleveraging. Tom will take you through the details in a few minutes. We acknowledge that the macroeconomic situation is challenging in a number of ways. However, the resiliency of our business model and our track record of execution makes us confident in our ability to continue to serve our customers and deliver our 2022 financial guidance. Moving to Q1 performance on Page 5. Q1 organic revenue increased 5.1%, and core revenue increased 7.3%. Total revenue grew 9.2% on a reported basis, including revenue contributions from Masterflex, Ritter and RIM Bio, offsetting the impact of foreign exchange headwinds. Revenues within approximately 90% of our end markets grew mid- to high single digits, including biopharma, where we realized more than 20% organic growth in our bioproduction platform. Advanced technologies and applied materials also grew high single digits driven by notable strength in our proprietary offerings into the semiconductor market and healthy growth across most other customer groups. Adjusted EBITDA in the quarter was up 16.5%, reflecting approximately 140 basis points of margin expansion resulting from the impact of our 2021 acquisitions, strong proprietary materials growth and commercial excellence and productivity efforts to offset inflation. Our strong operating results drove adjusted net income growth of about 15%, in line with adjusted EBITDA growth. We generated free cash flow of about $128 million in the quarter, up about 14% from Q1 2021 despite increased investments to support our growth. We remain on track to achieve approximately 100% free cash flow conversion for the year. Our adjusted net leverage ended at 4x adjusted EBITDA, down from 4.2x in December and in line with our 2x to 4x target leverage. With that, let me turn it over to Tom to walk you through our financial results in more detail.

Thank you, Michael, and good morning, everyone. I'm starting on Slide 6. We generated total revenue of $1.95 billion in Q1, representing a 9.2% reported growth rate. Our underlying core organic growth rate was 7.3%. And as you can see on the right-hand side of this page, this continues a multiyear trend of accelerating core organic growth. Our COVID-related headwinds in the quarter were 2.2%, in line with our expectations. As Michael mentioned, our COVID-related revenues are less than 3% of our total revenue and will represent a 2% to 3% headwind to our organic growth in 2022. The play within this range will be largely driven by global vaccine demand, which continues to be deliberated globally. To the extent that vaccine demand changes over the course of the year as booster requirements and other factors become clearer, we are confident that our aggregate revenues will remain intact given the fungibility of our bioproduction capacity to support both COVID and non-COVID demand. Revenues from 2021 acquisitions increased our revenues by 6.6%. More to come on this in a minute. And the stronger U.S. dollar created FX translation headwinds of roughly 2.5%. On to Page 7. From a regional perspective, Americas, which represents approximately 60% of annual global sales, achieved 6% organic revenue growth and 7.8% core organic growth driven by high single-digit organic growth in biopharma, health care and advanced technologies and applied materials. Within biopharma, our bioproduction business grew more than 20% with strong growth across process ingredients, excipients, single-use and serum. In health care, we saw a strong demand for our medical-grade silicone formulations as elective procedures continue to rebound. And within advanced technologies and applied materials, sales were driven by our proprietary offerings for semiconductor manufacturing. Europe, which represents approximately 35% of annual global sales, achieved 2.6% organic revenue growth in the first quarter and 6.3% core organic growth. Bioproduction grew almost 30% in the region driven by demand for single-use offerings, process ingredients and excipients. Advanced technologies and applied materials grew mid-single digits on an organic basis as a result of broad strength across all customers and product groups. Within health care, sales were relatively flat as double-digit growth from our medical implant platform was offset by headwinds in COVID diagnostic testing offerings that also impacted our European education and government business, which declined mid-single digits. EMEA, representing approximately 5% of annual global sales, achieved 11.7% organic revenue growth and 8.6% core organic growth in the first quarter driven by strong demand for our proprietary offerings in bioproduction and advanced technologies in applied materials. COVID-related sales delivered a modest tailwind due to ongoing sales of PP&E and vaccine-related products in the region. Slide 8 shows our organic revenue growth for the quarter by end market and product group. Biopharma, representing more than 50% of our annual revenue, experienced high single-digit organic growth in the first quarter, including more than 20% organic growth in bioproduction driven by strong demand across all of our offerings, including single-use, process ingredients, excipients and serum. Our bioproduction open order book continues to grow with non-COVID orders now comprising approximately 85% of the total. We see strong underlying industry fundamentals in bioproduction, including a healthy development pipeline across mAbs, cell and gene therapy and mRNA. There has been some noise regarding the health of funding in the biotech space, particularly for early-stage enterprises. These customers comprise a small percentage of our overall sales, and we remain positive on the biotech fundamentals given strong private funding sources, multiyear cash reserves, robust NIH outlays and high levels of clinical trials and pending approvals. We expect biotech customers to continue to play an important strategic role for Avantor by providing early access to the biopharma pipeline and see limited risks to the near-term R&D activity levels. Health care, which represents approximately 10% of our annual revenue, experienced mid-single-digit organic growth in the first quarter, driven by continued double-digit growth in our medical-grade silicone offerings partially offset by a decline in demand for COVID-19-related diagnostic offering. Education and government, representing approximately 15% of our annual revenue, experienced a mid-single-digit organic revenue decline in the first quarter driven by a roughly 10% decline in our government customer base as COVID-related demand, particularly for diagnostic testing and PP&E offerings moderated as expected. In the education market, sales were down modestly with growth in our university and K-12 segment, offset by global COVID-related headwinds in diagnostics and PP&E and supply chain constraints in our third-party instrumentation offerings. The funding outlook for universities remain strong. And we expect improving results as supply chain stabilize and research activities return to normal levels. Advanced technologies and applied materials, representing approximately 25% of our annual revenue, achieved high single-digit organic revenue growth in the first quarter driven by growth of proprietary materials to semiconductor and electronic device customers as well as broad strength across all customers and product groups in Europe and EMEA. Many of our semiconductor customers are currently undertaking significant expansions, and we are well positioned to increase our sales as they ramp up capacity to meet growing global demand. By product group, proprietary materials and consumables offerings achieved double-digit organic revenue growth driven by strong demand for our process ingredients, chromatography resins, excipients, single-use solutions and serum as well as for our biomaterials and electronic chemicals platforms. Sales of third-party materials and consumables declined low single digits, reflecting year-over-year declines in the COVID-related testing and PP&E offerings previously mentioned. Let me turn to Slide 9 to offer some perspective regarding our key financial performance metrics. In the first quarter, we achieved 16.5% growth in adjusted EBITDA and approximately 140 basis points of adjusted EBITDA margin expansion to 21.7%, reflecting the contributions from our 2021 acquisitions. And in our core business, volume growth, favorable mix, including double-digit growth in sales of proprietary materials and consumables, inflation management through commercial excellence and productivity enabled by our Avantor Business System. These positive factors were partially offset by increased cost of raw materials and freight as well as investments in our workforce made over the course of 2021 and into 2022. Adjusted earnings per share in the first quarter was $0.38, and adjusted net income was up approximately 15% driven by higher operating income partially offset by higher interest expense as a result of debt issued to finance the 2021 acquisitions and increased income tax expense as a result of higher pretax income. Free cash flow in the first quarter was $128 million compared to $112 million in the prior period. The increase was driven by higher operating cash flow and lower working capital investments than 2021 offset by an increase in capital spending to support our growth, principally capacity additions in our global supply chain. Turning to Slide 10, we have an update on the progress of our 2021 acquisitions. You will recall that we deployed approximately $4 billion for M&A in 2021, principally for the acquisitions of Ritter and Masterflex, which collectively have expanded our addressable market by approximately $12 billion in 2025. These businesses have a highly recurring specification-driven revenue profile and expand our proprietary offering to the biopharma and health care end markets. Masterflex is a leading global manufacturer of peristaltic pumps and aseptic single-use fluid transfer technologies that are used across all bioproduction platforms, including monoclonal antibodies, cell and gene therapy and mRNA and support both therapy and vaccine manufacturing as well as critical research activities. Ritter is a global technology leader in robotic liquid handling consumables, including conductive tips, plates, and other consumables, and has significantly enhanced our proprietary offerings for critical lab automation workflows. Collectively, we expect the acquisitions to generate around $0.5 billion of revenue in 2022 at EBITDA margin rates nearly double that of the core Avantor business. In Q1, the business has generated $117 million of revenue, $45 million of EBITDA and north of $0.02 in earnings per share. In terms of top line performance, Masterflex grew in line with our broader bioproduction portfolio, benefiting from the same healthy demand patterns across mAbs, cell and gene therapy and other emerging modalities. EBITDA contribution was ahead of our internal operating plan due to favorable mix and commercial excellence. The carve-out and integration process is progressing as planned, and we expect to transition the business onto our ERP and business platforms by the end of the third quarter. Ritter grew high single digits on a core organic basis when comparing the first quarter of 2022 to the first quarter of 2021, and EBITDA came in ahead of our internal operating plan. Although the business has faced more significant COVID headwinds than originally anticipated, the fundamental growth drivers remain intact, and we expect Ritter to continue growing high single digits on a core organic basis. As a stand-alone business, the integration of Ritter is nearly complete. We are now focused on executing our commercial integration plan, which principally consists of driving the existing offerings through our commercial platforms into the aftermarket and leveraging the technology platform to develop new offerings. We have ongoing conviction in the strategic and financial rationale for these acquisitions and are confident we will achieve attractive returns on the capital deployed. Moving to Slide 11, I wanted to give you an update on the expected impact from the rising interest rate environment on Avantor both in 2022 and in future years. This is a good news story as the actions we have taken in the past and more recently will enable us to maintain 2022 interest expense at our original guidance of approximately $260 million. For starters, if you look at the debt schedule in the appendix to the presentation, you will see that roughly half of our roughly $7 billion in debt is fixed rate denominated. Further, most of this fixed rate debt does not mature until 2028 or later, so good protection there. That leaves $3.3 billion of floating rate debt, of which $2.2 billion is U.S. dollar LIBOR-based, the remainder euro-based. All of this floating rate debt is freely repayable with no penalty. As you can see on the left of Slide 11, the U.S. dollar LIBOR forward curve has steepened since we issued our original guidance in January, creating upward pressure on future LIBOR-based borrowing cost. We have 3 levels of protection to offset the increases anticipated in 2022. First, our U.S. dollar LIBOR-based loans have a floor of 0.5%. When the LIBOR rate is below the floor, which was indeed the case for most of the first quarter, then our floating rate is set at 50 basis points plus the spread of 200 to 225 basis points. All interest rate increases up to the 50 basis points floor have had no impact on our interest expense. Second, in April, we executed a 3-year $750 million interest rate and cross-currency swap that converted LIBOR-based floating rate interest to lower-cost euro fixed-rate interest. Third, we have ample capacity under our lower-cost accounts receivable securitization facility, LIBOR plus 90 basis points, to continue to manage down our outstanding LIBOR-based floating rate debt, again, with no repayment penalty. As a result of these company actions, our 2022 estimated interest expense remains $260 million despite the rising rate environment. Looking beyond 2022, the Avantor debt maturity schedule calls for minimal mandatory debt repayments through 2024. And with free cash flow north of $1 billion per year, we are in a strong position to continue to handle the 2025 required repayment and pay down some or all, depending on alternative opportunities for cash deployment, of the 2026 and 2027 floating rate debt on an accelerated basis without penalty. Our strong free cash flow model and strategic debt profile have enabled us to reduce our leverage by approximately 1x adjusted EBITDA each year and leave us confident in our ability to continue creating significant value for our shareholders. On Slide 12, we provide an update on our full year financial guidance. Our 4% to 6% organic growth sales guidance is not changing. We are encouraged by our momentum and remain confident in our ability to offset expected COVID-related headwinds by strong growth in our core business. On adjusted EBITDA margin rates, we do anticipate continued strong margin expansion for the full year. However, we are exercising prudence given the dynamic macroeconomic environment and holding firm on the original margin guidance for now. Given the strength of our first quarter results and strong momentum, we are raising our adjusted earnings per share guidance to $1.48 per share to $1.54 per share, approximately $0.02 at the midpoint. We also remain confident on free cash flow and fully expect to achieve more than $1 billion for the full year. For the second quarter, a quick reminder that we are up against the 20% growth comp, our toughest of the year. With that said, we expect year-over-year Q2 growth and margin expansion to be similar to Q1 with continued strong performance in biopharma and advanced technologies and applied materials including full phase-in of 2022 pricing offset by higher COVID and FX headwinds than Q1. This concludes my prepared remarks. I will now hand the call back to Michael.

Thanks, Tom. I'm now on Slide 13. Despite the dynamic operating environment, we started the year off by delivering another outstanding quarter. I remain encouraged by the strong fundamentals in our end markets and by our traction with commercial excellence and productivity initiatives that will enable continued growth and margin expansion. The integration of our 2021 acquisitions is going well. And their first quarter financial performance has been well positioned to achieve their full year operating plan. Given the continued momentum of our business and ongoing deleveraging, we have the flexibility to consider additional capital deployment opportunities and remain active in building a strong M&A pipeline. We will continue to invest in our long-term growth strategy. You learned about our progress expanding manufacturing capacity earlier. I'm especially excited to add cGMP manufacturing capacity in Singapore for process chemicals, raw materials and excipients. As I mentioned earlier, the facility is designed to bring innovative solutions closer to biopharma customers in the region and boost supply chain capabilities, keeping breakthrough science moving forward. As I've mentioned before, we are committed to advancing sustainability through our Science for Goodness platform. With that in mind, we will be releasing our second sustainability report next month, which will include a Sustainability Accounting Standards Board Index. I hope you will read it and see for yourself the progress we are making in the areas of people and culture, community engagement, innovation and environment and governance and integrity. I want to thank you for your interest in Avantor 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 Instructions] We take our first question from Derik De Bruin from Bank of America.

So can we talk a little bit about the pricing environment? There was some concern during the quarter about pacing. I mean you did call out that you expect full implementation. Can you just give us some perspective on what you're seeing in terms of realized price increases this year, how does it compare to the past in the full year? And what sort of is like the pushback from your customers or at all? And sort of like how are your customers, your suppliers pushing that forward?

Derik, thanks for the question. This is Michael. A couple of things to keep in mind here around pricing, historically, as we've talked about roughly 1/3 of our growth would come from pricing, and roughly 2/3 of our growth would come from volume expansion. As we entered the year in line with inflationary environment that we're facing, we anticipated that algorithm flipping, meaning roughly 2/3 of our growth will come from pricing. And when we look at our results for Q1, we definitely see that coming into play. Now having said that, the way that our contracts and interactions with our customers play out for all the new business that we earn in this year, obviously, is priced at this year's pricing, we do carry forward some of the orders from 2021 that were in backlog into the new year that we priced at '21 pricing, that's pretty well worked its way out as we move through the quarter. So as Tom indicated in his remarks, at this stage in the second quarter, basically all of our '22 initial pricing is in play. And having said that, we have implemented additional increases and imagine that throughout the year, as inflation plays out, that we may need to go back to the market in the future but certainly have the flexibility to do that. Given the macro environment, we're certainly not doing anything that's unusual here. And the conversations with our customers are probably a bit more around the security of supply and leveraging our supply chain to keep volume flowing into their facilities.

Great. And can we get a little bit more clarity on some of the performance of your deals? Specifically, I mean, $117 million for each -- or for the -- in total, can we get some specifics on what that breakout was? And how much of -- how big of a headwind is COVID in those businesses this year versus your original expectations? Basically, what's the core base for last year ex COVID on these businesses and thinking about that because it looks like you're doing your growth rates on an ex COVID basis?

Thanks for calling out the value we're creating here through these acquisitions we completed last year. We remain very excited about all 3 of them. And as we indicated in the remarks as well as in the presentation, the 3 deals are running ahead of our internal operating plan in the quarter, and we're well on schedule to achieve our full year plan. Masterflex, obviously being the biggest of the 3, having the most impact on the numbers, running in line with our own production business and is on track to achieve the $300 million that we disclosed at the time of the deal for this year. . Ritter is the one where we've had a little bit of noise. We knew that about 15% to 20% of the revenue was COVID related and had that coming out of our deal model just not too quickly as it has come out. It obviously came out relatively quickly in Q3 and Q4 where at this point, we're probably plus or minus worked our way out from that. So the underlying core business then, which is obviously what we acquired, growing very much in line with our expectations here of high single digits. We are quite excited about the traction we have with the existing portfolio, moving that through our channel into our -- the end customers. And we're also very excited about the investments that we're making in leveraging the asset as a center of excellence for high-precision consumables manufacturing and we're getting great traction on a series of new product launches that expand our portfolio there. So we are super excited about the contributions from all 3 of these deals and very confident that we'll achieve the returns that we would anticipate and how we deploy capital.

And Derik, just to add to your question on the split, I mean, you'll see it in our 10-Q for the quarter, roughly $70 million for Masterflex, roughly $50 million for Ritter. The other thing I want to point out on Ritter is at the time we did the deal, it was about -- the euro was about $1.20. That's now in the $1.05 range. So that is contributing to, at least on a U.S. dollar basis, headwinds in addition to what Michael mentioned. But the underlying core organic growth continues to be in line with our expectations.

The next question comes from Vijay Kumar from Evercore.

Congrats on the print. Thanks for all the details. Just given the questions, might as well head into Q1, maybe one on the guidance here. Big picture when you look at Q1, you guys did [Indiscernible] And like Tom mentioned 20% comp for 2Q, are you still expecting to do something similar to Q1? As you think about the back half, is there upside here as you think about some of the moving parts here, whether it's pricing, supply chain or perhaps at the macro and locked on years. Maybe just talk about when you declared that 4% to 6%, should we be looking at towards the upper half?

Thanks for the support, Vijay. A couple of ways to think about the 4% to 6%. Firstly, we have a high conviction around being able to deliver on that guidance on a full year basis. You obviously noticed that we increased our outlook on EPS, which really is a reflection of our conviction around not only trending towards the upper end of our organic guide but also confidence in being able to deliver on our margin expansion guidance as well. We called out in the quarter here expectation that COVID headwinds on the year will likely fall in this 2% to 3% range. Models go higher than maybe where we were thinking about coming into the year. And despite that, the strength of our core growth is obviously able to absorb that, and we're pleased with the momentum that we do have. One note about those COVID headwinds, as Tom indicated in his note, kind of play in that range is likely going to be driven by where vaccine demand ultimately lands this year. And we think we're well positioned there with -- and have well bracketed any potential downside there and how we've accounted for our outlook here through a couple of factors. Firstly, we obviously have an order book that's noncancelable, that we have good line of sight to. And to the extent that additional demand doesn't materialize, we obviously have an order book for our core business that continues to expand and is -- over time, has more prominently shifted towards our core business and now stands at roughly 85% of our open order book. And bioproduction is our core business. The capacity is fungible, and so any potential vaccine headwinds will materialize, we're going to be more than able to offset through our -- redeploying that capacity to satisfy the bulging order book for our core business. So we're well positioned to continue to drive ahead here and certainly have a high confidence in delivering that range, if not the upper end of that range.

That's helpful, Michael. And maybe one perhaps for Tom. The Q1 M&A contribution that's annualizing -- again, I'm nitpicking, which has given the amount of focus that we've had on these issues, I think it's helpful to be clear. The $117 million annualizes to about something like $470-ish million. But when you say we're still on track for $500 million, is there a timing element here, a cadence issue, a comp issue? Can you just talk about the confidence in that $500 million? And when you think about the free cash flow, free cash flow growth of about 20% year-on-year, how much of this is a timing, Tom, versus underlying improvements?

Thanks, Vijay. Yes, first, on the M&A. I would say -- I mean, your math is -- I don't disagree with your math, but the incremental growth that we've seen in both the businesses quarter-to-quarter-to-quarter does support our view on that $500 million. For example, if you look at Q4, I think our revenues were 90-ish or so. That was missing a third month for Masterflex. But when you put that in, you're around $108 million, $110 million in revenue in Q4 going to $117 million in Q1. So the incremental sequential growth is what is giving us confidence. And if you can see adding $5 million or so to the quarterly performance, you can easily get to the $500 million, which is our expectation. On free cash flow, 20% growth, I think a little bit more modest but I would say that it is really operational. In fact, if you compare first quarter 2021 and 2022, you'd see that we actually had favorable working capital experience in terms of dollars. And the growth from the acquisitions is obviously helping us as well in addition to the underlying growth of the business. So there's nothing unusual except I think healthy conversion of our profits. Q1 is typically our low point of the year for free cash flow given various onetime payouts, whether it's tax or employee bonus, et cetera. I'm fully confident in the $1 billion for the full year, which will be a nice increment from 2021. And Vijay, I know you're one of our bigger free cash flow fans. Remember, we were less than $200 million when we started 3 years ago. So to be 5x that, I think, is -- it speaks to the performance of the model.

We take our next question from Dan Brennan from Cowen.

Congrats on the quarter. Maybe the first question, just on the pacing, if you don't mind, so you basically -- just want to be understanding it clearly. So you're saying basically Q2, despite the tougher comps, you're going to achieve similar growth rate as you saw in Q1. So basically, you would have somewhere in the ZIP code of 5% organic, 7% ex core organic. So that would imply a pretty decent step up on a stacked basis. I just want to ensure I'm understanding the messaging about pacing in Q2.

Yes, I think you've got it right, Dan. The -- remember that the first -- or sorry, the second quarter last year, we were -- total organic growth was 20%. And so we're up against the, as I said, the toughest comp of the year. But underlying trends, order patterns and so forth have us confident in the 4% to 6% growth rate for the year, including good growth for the second quarter. We've mentioned a couple of times that we've got strong order books particularly for our proprietary businesses. Proprietary grew in the teens in the first quarter. We expect that to continue. We also have good momentum from the commercial side. Pricing, as we talked about, has reached its point of full implementation by the end of the quarter. So sequentially, Q1 to Q2, you should get a little bit of lift on the top side from that as well. So it is well supported. And so far, we're -- what we're seeing, we haven't closed April. But we are confident in the full quarter outlook.

Okay. And then maybe on COVID, while certainly the contribution to your business is smaller than peers, I just wanted to understand, again, might be updated view, the 2% to 3%. So on the 3%, that all comes out of the vaccine side. So previously, we were assuming $200 million in vaccine-related revenues this year, $50 million in test and other. So presumably now with the 2% to 3%, it should be something in the ZIP code of -- could be somewhere $125 million on vaccine therapeutic at the lower end, but the testing and other remains 50%. I guess that's the first part of the question. And then the second part would be just given the confidence in the fungibility of your capacity to meet -- any slowdown to kind of meet it with the base business, would you be willing to share additional color on the size of the backlog on the base business and/or the growth rate you said was 20% plus on the base business? Was the order growth rate at that level? Was it higher or lower? Anything of that would further help instill confidence.

Yes, let me take that question. On the 2% to 3% expected headwinds for the year, to get to the 3% range, you're probably also going to need a bit of deterioration on the testing side of things as well. So in the worst of scenarios, is it $50 million to $75 million of additional headwinds on the vaccines, yes, perhaps in that range. I'm not sure I could quite get to the high end of that, but that would certainly bracket that. On the core side of our order book on mile production, as we've said in previous calls, it continues to trend at roughly full year's worth of demand. And as I sit here today, perhaps even a bit ahead of that at this stage. So clearly, more than enough demand to be able to soak up any of the additional capacity that we might not need to support the vaccine outlook. We've got an order book for the vaccines, as I said before, that's certainly supportive of our views here. A lot of uncertainty around is there going to be additional demand that comes through associated with any fall booster season or not. But we're not needing that or counting on that in any way to be able to deliver on the guidance that we've got here. We're very confident we can offset anything that comes there through our core business.

Next, we have a question from Jack Meehan from Nephron Research.

I wanted to ask again about just the cadence of the margin expansion specific as it relates to the first quarter. I think originally entering the year, the model assumed the first quarter was going to come in lower given some of the factors you've laid out and now ultimately delivered 140 bps of expansion. So I was just curious if you could kind of articulate where the upside came from in the quarter and just maybe how much of that might have been related to how you exited the quarter toward the end of March.

Yes. Thanks, Jack. Yes. So just to reiterate, the original guide was 125 basis points of margin expansion over the course of the year, and 140 was what we delivered in the first quarter. When we talk about the $175 million, we said that $50 million to $75 million of it would come from the core organic business and, call it, $50 million to $75 million from M&A. We're probably in the first quarter a little bit higher on the M&A contribution than on the organic contribution. And that was as anticipated given the dynamics we talked about around the timing of pricing and inflation. But as we look forward, I think that balances out a little bit more as we see our expansion going forward. I do fully expect that the core business, the organic business pre-acquisition is going to be contributing as much as the M&A one.

Great. And then in the prepared remarks, you called out kind of the potential for increased demand on the semiconductor side with reinvestment there. Can you just remind us what percentage of sales comes from that area, what products you serve the market with and just talk about what you're seeing on the ground in terms of demand today?

So Jack, our exposure to the semiconductor space gets reported in our advanced technologies and applied materials end market, which collectively is around 25% of our overall revenues. Within that, semi is probably a couple of percentage points in that range, 2 or 3 points. And we have a pretty comprehensive solution into that space, including a lot of supplies to help manage their clean room environment, a number of services that we supplied. Perhaps most importantly, though, we supply a proprietary -- a set of proprietary formulations that are used in the actual manufacturing of the wafers themselves that provide etching and cleaning functionality in most of the process steps that are required to produce a wafer, which in today's technology, to produce a wafer, you're talking more than a couple of thousand process steps to make that happen, and our materials are going to be used as a function of a number of steps. Clearly, demand for semiconductors is very, very strong. We're growing double digits in that space. There's been some pretty high-profile announcements of expansions around the world, including here in the United States, and we're well positioned in that space with the technologies that we supply on a proprietary basis to continue to be an important supplier into that space. Clearly, a lot of momentum, and we're well positioned to continue to benefit from that.

The next question comes from Tejas Savant from Morgan Stanley.

Tom, maybe just a quick housekeeping one for you to kick things off. What exactly is the FX headwind? I'm not sure you mentioned it in your prepared remarks or maybe I missed it.

Yes, for the quarter, it was roughly 2 percentage points. And when you look at -- as you call it, $40 million or so on the top line. And for the full year, we now expect that to be in the range of a couple of hundred million, $200 million or so is what I'd say.

Got it. Makes sense. And then Michael, one -- yes, go on.

The 2%, I should have said it's closer to 2.5%, so somewhere in that range, but it is the $40 million I'm talking about.

Got it. That's helpful. And Michael, one for you on the geos. So obviously, China is relatively small for you here. Any thoughts on when things normalize there? And then more importantly, on Europe, which is a significant region for you, in light of the energy dependence there on Russian natural gas and some of these payment deadlines approaching and Russia threatening to turn off the supplies here, what exactly are you contemplating in your guide in terms of the macro backdrop in the back half of the year? And do you expect to be sort of essentially recession-proof given your proprietary product and consumables mix even under that scenario?

Yes, a couple of things. Firstly, on China, your read is correct. We have very limited exposure there, although we are -- remain bullish on the long-term outlook there, and we continue to invest. No meaningful impacts to date, and clearly, no real insight as to when things might improve or how they might evolve as we move forward. Obviously, it's a tough situation out there that they're dealing with. But as we sit here today, limited to no impact on the business. In thinking about Europe, we obviously did come up pretty strong quarters here where it's important to recognize that, as we've said from the beginning of the pandemic, our testing exposure was disproportionately centered in Europe. And so naturally, as the testing comes down, the headwinds are going to be a bit stronger in Europe than in other regions. So organic growth of a couple of 100 basis points on a core basis, we grew that business in Europe at north of 6%. So really strong performance in Europe in the quarter with strength really across each of our end markets, including some of the industrial areas. We do have assets and facilities that are important to our supply chain throughout the region there. And as we look at the situation today, including our facilities in Poland, everything continues to run normally. We'll continue to watch the situation unfold, it's all pretty dynamic. But we're confident in that we have a large global footprint that gives us a lot of optionality. And certainly, as we look at the things we've been able to do to keep our customers served throughout the pandemic, leveraging this optionality, we're kind of confident in our ability to continue to do that and take some solace in the momentum that we've got exiting for the first quarter.

We take our next question from Matt Sykes from Goldman Sachs.

Just my first one just on sort of M&A plus the interest rate mitigation that you did. It's good to see that the floating rate risk has been mitigated for this year. But as you think about M&A and where your leverage ratio is now, is paying down debt still a priority just given that longer term there still is that interest rate risk on the floating rate side? Or are you kind of doubling down on the M&A for this year in terms of the pipeline, the valuations and everything that's compressed in 6 months?

When I think about our capital allocation priorities, I think you've hit the 2 elements here of continuing to be focused on M&A and deleveraging. I think we have a pretty clear algorithm on what it would take for us to do a deal. We've, I think, showed great discipline to date, and you should expect similar discipline going forward. We do have a strong pipeline that we continue to execute, and if the right deal comes through that, we would be thrilled to be able to get something done this year. But if not, clearly, there's a lot of value that can be created by continuing to deleverage the business.

Great. And then just on the education and government segment, you called out a number of COVID headwinds. Anything else in that end market that you would call out in terms of contributing to that mid-single-digit decline? Or is it mostly COVID and we expect that to alleviate over time?

Exactly. You got it right. Particularly on the government side, where we participated in a number of government-sponsored COVID relief efforts around the world, really in all 3 regions, that whether it be PPE or testing support, that diminish over time. So as we work our way out of that, you should expect that space, particularly the vacation piece, to return to more normalized growth levels.

We take our next question from Patrick Donnelly from Citi.

Just another one on the deal side. For Ritter, I just want to see the visibility into orders. I mean is it fully transparent from customers, they're using the product for COVID versus not? Just trying to get a sense for confidence on that high single-digit underlying number given the revenue over the past few quarters. And similarly, Masterflex, just how should we think about COVID exposure there? It sounds like, again, you're kind of thinking anything that comes out is going to remain fungible on kind of the bioprocessing side. I assume it's the same there, but I just wanted to talk through that as well.

Let me take those, Patrick. On the Ritter side, the customer base that we had for that business at the time of the acquisition was primarily an OEM-driven model. And given that this business follows the same business model as our other proprietary businesses and technologies that we have, meaning some product is actually specified into our customers' workflow by the customer, we do actually have pretty good line of sight to how the product is being used. And in this case, we were aided a bit, in fact, in that the customer base was relatively limited at the time of the acquisition. The benefit that we get now, obviously, is being able to translate these technologies across now several hundred thousand customer locations around the world that are engaged in life science research and diagnostic testing, where we can now reach these -- the end markets on a direct basis. So we're certainly excited about the translation in being able to do that. You had a second part to your question?

Yes. Just on Master Flex in terms of how to think about the COVID exposure there. Is it fungible or kind of similar to what you're talking about with the other bioprocessing?

Yes, it's very, very similar in how we think about our own bioproduction business. There clearly is a bit of COVID exposure there as it relates to supporting some of the vaccines but a very, very strong order book, similar mix is what we have in our legacy bioproduction business, and I think we think about it exactly the same line.

Next, we have a question from Paul Knight from KeyBanc Capital Markets.

On the bioprocess order book, could you talk about you're seeing accelerating demand? That's obviously in spite of COVID. Is it -- are companies taking up product as they kind of get off of vaccine programs and back to traditional monoclonal cell and gene and other programs? So what are the dynamics you're seeing on this growth, I guess, is the broad question?

Yes. It -- as we've indicated throughout the pandemic, the underlying core business that we're supporting, which we're agnostic to therapeutic area, we're agnostic to modality, we're going to have broad exposure across all. The demand for those products has not waned throughout the pandemic and continues to grow at a pretty aggressive level. So the demand has been there. We've had demand through some raw material and other capacity constraints as we balance supporting both vaccines as well as the broad therapeutic base. So the demand has been there and it's been very, very strong. Our order book has continued to build throughout the pandemic with a lean towards the core business. And as incremental capacity and raw material availability through the value chain is made available as we transition away from the vaccine, that just allows us to satisfy and pull forward some of the orders that we have on the books for our core business.

And then lastly, are you able to see if the hope for pickup in cell therapy and mRNA is happening in the market?

As we've experienced demand and growth in the market and as we anticipate growth over the next couple of years, it's still going to be largely driven by the monoclonal antibody workflow. That's the lion's share of the commercialized platforms, continued great momentum, continued build of the pipeline, and that's going to be the core driver. Certainly, the 2 modalities that you mentioned are starting to gain traction. Cell and gene therapy is obviously a bit ahead and has a pretty exciting platform. And as you heard into my prepared remarks, we've launched some products specifically targeting that cell and gene therapy market and put in place some partnerships that help us expand our offering there. And we continue to be bullish and well positioned to service what we do think is going to be a pretty exciting growth opportunity. COVID has accelerated the mRNA market dramatically. And for both vaccine development beyond COVID is probably going to front-run the near-term opportunities there, which we should be able to participate in as well as the therapeutic area. And that will certainly be a helpful tailwind for all of us in the biologics space in the years to come. But I wouldn't discount the importance of monoclonals. That still drives the lion's share of the revenue for our end customers.

This now concludes our Q&A session, so I'll hand it back to Michael for any closing remarks.

Yes. Thank you all for participating in our call today. As we close, I would certainly be remiss if I didn't express my continued gratitude for the ongoing efforts of all of our associates around the world who are living our values every day and setting science in motion to create a better world. Hopefully, you sense our confidence and excitement about what lies ahead for Avantor, and we look forward to updating you when we meet next. Until then, take care and be safe, everyone.

Thank you all for joining today's call. This now concludes the call. Please disconnect your lines.