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Edited Transcript of AVTR.N earnings conference call or presentation 5-Nov-19 1:30pm GMT

Q3 2019 Avantor Inc Earnings Call

Nov 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Avantor Inc earnings conference call or presentation Tuesday, November 5, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Stubblefield

Avantor, Inc. - President, CEO & Director

* Thomas A. Szlosek

Avantor, Inc. - Executive VP & CFO

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Conference Call Participants

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* Brandon Couillard

Jefferies LLC, Research Division - Equity Analyst

* Daniel Gregory Brennan

UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences

* Derik De Bruin

BofA Merrill Lynch, Research Division - MD of Equity Research

* Doug Schenkel

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Erin Elizabeth Wilson Wright

Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst

* Jack Meehan

Barclays Bank PLC, Research Division - VP & Senior Research Analyst

* Tycho W. Peterson

JP Morgan Chase & Co, Research Division - Senior Analyst

* Vijay Muniyappa Kumar

Evercore ISI Institutional Equities, Research Division - MD

* Helen O'Donnell

SOLEBURY TROUT LLC - MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Avantor Third Quarter Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Helen O'Donnell. Thank you. Please go ahead.

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Helen O'Donnell, SOLEBURY TROUT LLC - MD [2]

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Thank you, operator. And good morning, everyone. Thank you for joining us on today's call. 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 the presentation accompanying this call are available on our investor website at ir.avantorsciences.com. A replay of this webcast will also be available on our website following this call. Following our prepared remarks, we will open the line up 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 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.

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [3]

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Thank you, Helen. And good morning, everyone. We appreciate you joining our third quarter earnings call.

Let's get right into the performance for the quarter. I'm on Slide 3.

Organic revenue growth was 2.4% for the period, which reflected a couple of factors. First, our strong growth in the biopharma end market continued in the quarter. We were up 7% on an organic basis and are up 10% for the year. You may recall that biopharma represents approximately 50% of our annual revenues, and continued momentum in this end market is a critical element of our model. This growth was partially offset by a low single-digit decline in education and government, which had significant growth in 2018 driven by the initiation of a new customer contract. Tom will share more details later, but this contract affected the year-over-year comparison by more than 200 basis points.

Turning to adjusted EBITDA. We continued to make excellent progress on managing product pricing relative to product cost inflation and delivering the synergies from the VWR acquisition. However, the positive impact of these factors was offset by foreign currency headwinds and adverse product mix, which together diluted margins by approximately 100 basis points in the quarter. The one-off issue in education and government that I mentioned previously also contributed to the margin performance. We will provide more details in a few minutes, but we are confident that our long-term growth and margin expansion model is intact.

Q3 was an excellent quarter for earnings growth, as our adjusted earnings per share increased 49% driven by our operating performance and the ongoing benefits on interest expense from our deleveraging. We remain on track to deliver adjusted earnings in a range of $0.55 to $0.58 per share for the full year.

There was also an outstanding quarter for cash flow generation and continued deleveraging. Our unlevered free cash flow in the quarter was $206 million, representing 127% of adjusted net income. Working capital was the main contributor to the free cash flow improvement. Net leverage declined to 4.8x in the quarter, down from 5x at the end of the second quarter and from 7x at the beginning of the year. In addition to the impact from the IPO earlier this year, we are on track to reduce leverage through operational performance by almost a full turn this year.

While we are pleased with the progress we made in the quarter, there were some notable headwinds worth mentioning. The quarter started off somewhat slow, and we saw a modest tightening in capital expenditures, particularly in Europe. Industrial end markets, which represent approximately 25% of our revenue, also continued to be soft around the world. Despite these challenges and excluding the onetime impact we encountered in our education and government end market, we were able to deliver mid- single-digit growth in our core business. Also, we were encouraged by the momentum of our business in September that has carried forward into the fourth quarter. Our exposure to biopharma, including the high-growth bioproduction space; our global presence; broad customer access; and a highly recurring revenue profile make for a resilient model that performs well across economic cycles.

I am moving to Slide 4, where on the left you can see highlighted the sales growth, synergy execution, adjusted EPS growth and continued balance sheet deleveraging that I previously discussed. I would like to take a minute to cover some nonfinancial highlights.

We were pleased to expand our share of wallet with several existing biopharma customers. One notable example is an existing account which we previously only served in Europe. After understanding the value of our integrated offering brought to its European business, this global biopharma customer decided to expand the contract on a worldwide basis. We also won multiyear contract extensions with several top-tier biopharma accounts; and successfully onboarded several new customer accounts, including some important wins in CRO and education space. During the quarter, we began work to expand our innovation center in Bridgewater, New Jersey. By nearly doubling our footprint, we will be adding capabilities to support our customers in the areas of downstream processing and cell and gene therapy. We also began work to increase production capacity for high-purity, "low end of toxin" sugars used in both the upstream and downstream workflows of the biologics manufacturing process. We anticipate that this new capacity will be online by the end of 2020.

Our digital offering remains a key driver for our business model, and continually enhancing user experience is a priority. We implemented additional improvements throughout the third quarter and see additional online traffic leading to revenue growth across our platform.

In September, we announced that Bjorn Hofman, the leader of our manufacturing and procurement teams, plans to step down from Avantor later this year to join New Mountain Capital, our private equity sponsor who continues to own approximately 20% of the company. Bjorn has been a valuable member of our executive team for the past 5 years, and we appreciate his contributions to our growth and execution. The good news is that Bjorn will be with us for as long as we need him and will be available to us even after his official transition.

With Bjorn's departure, we are pleased to welcome Tanya Foxe, who recently joined as Executive Vice President, Global Operations and Supply Chain. Tanya brings a wealth of experience in supply chain management from her prior roles at Johnson & Johnson as well as at Avon, Walmart and Ford. Her leadership and experience will be critical in helping us build a fully integrated end-to-end supply chain that will further strengthen our overall value proposition to our customers around the world.

With that, let me turn it over to Tom.

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [4]

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Thank you, Michael. I'm on Slide 5, where you can see the 2.4% organic growth and the breakdown by region. The quarter was a bit lumpy with low single-digit growth in July and low single-digit contraction in August. However, we were pleased to see this trend reverse in September when growth returned to the mid-single-digit levels. And it is important to note the challenging comparisons we had in the quarter considering the 9% organic growth we had in the third quarter of 2018.

The 1% growth in the Americas stands out, as this is where the effect of the 2018 one-off that Michael mentioned materialized. For this single account in the education and government space, we had more than $40 million of sales in the third quarter of 2018, reflecting the ramp-up at the start of this new contract. In 2019, a large portion of the revenue for this contract was recognized in the second quarter. Additionally, not all the Q3 2018 volume repeated, as some portion of the ramp-up was to establish a threshold level of inventory to service the business. Absent this factor, the Americas growth would have exceeded 4% in the quarter, and the growth for the entire company would have approximated 5%. Europe was strong at 4.5%, with growth across all of our end markets, including high single-digit growth in biopharma. AMEA at 8% grew a bit more modestly than we have seen recently, although biopharma reported low double-digit growth. And we had a very strong month in September growing well into the double digits.

Let me move to Slide 6 for a very quick look at sales by end market and product group. As you can see, biopharma grew in the high single-digits, while health care and advanced technologies and applied materials were flat. Education and government, as previously noted, had a low single-digit decline. By product group, proprietary materials and consumables declined low single-digits, which in large part reflected the Americas education and government one-off we have been describing. I will talk more about this product group when covering our adjusted EBITDA performance. Third-party materials and consumables grew mid-single digits. The services and specialty procurement group grew by low double-digits. And the equipment and instrumentation group grew low single-digits, where we saw customers moderate capital expenditures.

Slide 7 is a summary of our adjusted EBITDA, free cash flow and adjusted EPS performance. As Michael indicated, we did well on product pricing versus product cost inflation and on synergy realization but had about 100 basis points of dilution from adverse foreign exchange and mix. I'll cover this in more detail on the next slide. Cash flow in the quarter was strong. Unlevered free cash flow was $206 million, up 48% and is up 34% for the year-to-date. Our leverage position continues to improve, as we ended the quarter at 4.8x, down from approximately 5x at the end of the second quarter. We expect to see further progress in the fourth quarter.

Last, the 49% increase in our adjusted earnings per share reflects the operational performance and the ongoing benefits on interest expense from our deleveraging.

Slide 8 shows the adjusted EBITDA bridge from the third quarter of 2018 to the third quarter of 2019. Starting with the $13.7 million price/volume factor. We had flat volume in the quarter, reflecting the netting of some very strong growth in biopharma against the negative impact of the one-off in our Americas education and government business. Single use and serum volumes in the Americas were particularly strong. Product pricing relative to product cost inflation performance was also strong, particularly in the Americas. This was offset by timing of supplier and customer rebates. The productivity factor reflects our continued realization of the SG&A synergies from the VWR acquisition, around $9 million in the quarter, largely offset by non-COGS inflation and approximately $5 million in strategic investments. These investments are mostly targeted to customer-facing sales and marketing functions and to new supply chain facilities to support growth in the AMEA region.

Sales mix had an adverse impact in the quarter but is something we view as temporary in nature. Part of our margin enhancement strategy is to drive the sales of our proprietary products, which are accretive to margins. We have been very successful in doing this. And in fact, for the 6 quarters preceding this quarter, the sales growth rate for proprietary products had exceeded the sales growth rate for third-party products, but in the case of this third quarter, sales of our proprietary products were down, as I mentioned earlier. The one-off sales decline in the Americas education and government business was the main factor here. This customer volume is largely comprised of proprietary products. Similarly, in the Americas we experienced a normalization in sales of proprietary materials to the health care space compared to the third quarter of 2018 when sales of these materials grew 25%.

Foreign currency is the last bridge item I want to cover. We've been experiencing foreign currency headwinds all year. The impact was the most intense in the first quarter when, for example, we were comparing a 2018 euro exchange rate of $1.23 to 2019 at $1.14, a $0.09 gap at that time. For the third quarter, this difference was down to $0.05, to $1.16 versus $1.11, but it still created a $6 million year-over-year headwind for us. We expect this impact to narrow further in the fourth quarter. Combining a $6 million FX impact and a $9 million mix impact, we realized an approximate 100 basis point contraction in margins from 2018. This is not something we expect to continue.

Slide 9 has our segment results. As I indicated earlier, the 1% organic revenue growth rate in the Americas exceeded 4% absent the one-off revenue decline in education and government business. We also exited the quarter with mid-single-digit growth for the month of September. We enjoyed another solid quarter for the biopharma business, our largest customer group, with sales up mid-single-digits, reflecting new customers and strong volume growth from customer spending on research and development. The bioproduction business also remained strong, with low double-digit growth. This strength was partially offset by a mid-single-digit contraction in health care, which reflected the normalization I mentioned earlier in sales of proprietary materials to the health care space. Absent the normalization from this customer, Q3 sales for Americas health care would have been up 3%.

We experienced mid-single-digit contraction in education and government. Apart from the one-off item, we actually experienced improved performance in the remainder of this end market, especially in higher education where we had some recent customer wins. The advanced technologies and applied materials end market was down low single digits driven by high single-digit decreases from food and beverage, agriculture, semiconductor and chemical customers, reflecting softness in the industrial sector. This was partially offset by growth in our aerospace and defense platforms.

Despite the more challenging revenue comparison, the Americas region reported an improvement in the Management EBITDA margin rate, which reflected strong product pricing relative to product cost inflation and SG&A savings driven by the VWR synergies and lower incentive compensation accruals. These were partially offset by the adverse mix factors and timing of customer rebates that I referenced in the overall adjusted EBITDA margin bridge.

In Europe, net sales increased approximately 4.5% on an organic basis, with roughly equal contributions from improved pricing and volume growth. Sales to the biopharma end market increased high single-digits from broad-based strength across strategic customer accounts and new customer wins. The health care segment experienced mid-single-digit growth largely due to strong sales of proprietary materials, partially offset by declines in third-party consumables and equipment and instrumentation products. Sales to education and government consumers grew in the low single-digits. We were successful in winning new government projects, but these gains were partially offset by contraction in equipment and instrumentation sales. Advanced technologies and applied materials recorded low single-digit growth driven by higher sales of third-party materials and consumables and relatively flat sales in electronic materials.

Europe had a modest improvement in the Management EBITDA margin rate. We had strong product pricing relative to product cost inflation performance, modest volume leverage, a favorable mix of sales and SG&A savings driven by the VWR synergies and lower incentive compensation accruals. Offsetting these were the unfavorable transactional foreign currency headwinds and the timing of supplier rebates.

The AMEA region reported organic sales up 8.2% due to growth in biopharma and advanced technologies and applied materials, our 2 largest end markets. We exited the quarter with over 30% growth for the month of September. The biopharma business experienced low double-digit growth driven by increased volume in lab products primarily through sales of third-party materials and consumables. These were partially offset by a decline in sales to biopharma production customers driven by challenging prior year comparisons and the timing of customer production campaigns, offset by stronger sales of single-use offerings. Advanced technologies and applied materials experienced mid-single-digit growth driven by sales of third-party materials and consumables. Sales of electronic materials were flat year-over-year.

AMEA had a decline in the Management EBITDA margin rate from 24% in 2018 to 20% in 2019. We had modest volume leverage offset by a slightly dilutive mix of product sales and investments in customer-facing sales and in marketing functions and new supply chain facilities to support future growth.

Turning to Slide 10, I want to share some more detail on cash performance for the quarter. For grounding, the green bars on the left show free cash flow, which grew from $99 million in the third quarter of 2018 to $185 million in the third quarter of 2019. Net working capital contributed approximately $80 million of this $86 million improvement, as you can see in the table on the right. We are clearly getting some traction from the leadership attention this area is receiving. However, we still have an opportunity for significant further improvement. You'll also note that the improvement in free cash flows from lower interest costs driven by our deleveraging was largely offset by higher payments for income taxes, as our net operating loss deductions begin to expire. Excluding cash interest, which is shown in the blue bars, the unlevered free cash flow grew from $139 million in 2018 to $206 million in 2019. This cash generation enabled approximately $157 million of cash deleveraging in the quarter.

Speaking of deleveraging, slide 11 gives a quick update on leverage at the end of the quarter. We started the year at 7x and reduced it to 5x by the end of June and further reduced it in the third quarter to 4.8x. We expect our leverage ratio to approximate 4.5x by year-end and continue targeting a long-term leverage ratio in the range of 2x to 4x.

Looking ahead, there are some opportunities with our debt structure to further reduce the interest burden. In particular, our $2 billion in senior unsecured debt with a 9% coupon and our $1.5 billion in senior secured debt with a 6% coupon offer attractive opportunities for refinancing in the second half of 2020. We will share more detail as we get closer to that date.

Our full year revenue and earnings guidance is on Slide 12. We are adjusting our full year outlook to reflect the third quarter performance and foreign currency differences between our original guidance and the current environment.

We now expect full year revenues to be in the range of $6.02 billion to $6.08 billion with organic growth of 5% to 6% and adjusted EBITDA in the range of $1.025 billion to $1.035 billion or an increase of 8.4% to 9.4%. At the midpoint, the new guidance reflects a 1% reduction in revenues and a reduction in adjusted EBITDA of approximately 2%.

Our guidance for adjusted earnings in the range of $0.55 to $0.58 per share or an increase of 52% to 60% remains unchanged.

With the updated guidance, we expect a very strong fourth quarter with inferred sales growth of 5% to 6%, EBITDA margin expansion in excess of 100 basis points and adjusted EPS growth of 57% to 87%.

I will now turn it over to the operator to begin the question-and-answer section.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Tycho Peterson from JPMorgan.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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Tom, I want to kind of go back to kind of how the quarter played out. If we go back to September, you had made some comments about Europe being soft, and that ended up being fine. And conversely, with the Americas, that came in a little bit light against a tough comp that you kind of knew about. So can you just talk a little bit about where you're feeling better or worse geographically coming out of the quarter? Were you surprised at the reversal in Europe? And are you able to talk at all about October trends? I know you said September was really strong.

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [3]

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Yes. So happy to take that. Thank you, Tycho. Just starting with Q3, the -- when you look at the growth by month, it's kind of interesting. We were -- and I think I tried to say in the comments -- we were kind of in that 3%-ish range in the month of July and we actually went negative in August. And it was in part in Europe where we were seeing that. And the month of August is tough always to kind of base a full year projection given schedules and vacations, particularly in Europe, but we definitely were sounding a cautionary tone after seeing that. But I'd say that September was very strong for us across the board, meaning the Americas was mid-single digits. Europe was high single-digits and Asia, as I said, was well into the double digits. So very strong month of September. In terms of October, we're not closed yet, but we are trending in line with the guidance that we provided for the full year as well as what that implies for the fourth quarter. So I think off to a reasonably good start for the quarter. And it's going to be a pretty strong quarter relative to Q3.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [4]

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And on Asia, I was a little surprised that AMEA didn't do a little bit better given that the comps slowed. I know you called out some timing issues on bioproduction. How much of this was just kind of pacing, timing of manufacturing campaigns versus a broader slowdown? You're obviously operating a small base there.

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [5]

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Yes. Tycho, this is Michael. I'll take that question. I think a couple of things to keep in mind for AMEA. Firstly, just the relative magnitude of AMEA for us is roughly 5%. And the way our portfolio has been built out there, it's skewed more towards the production environment than the other 2 regions that we participate in. So we do see a little bit more volatility in Asia owing to just the batch and campaign cycles that our customers bring us into. And if you look at the third quarter specifically in bioproduction, in 2018, that was in fact the high watermark for us in the region. There were a number of really, really significant campaigns that we participated in that, just based on the timing this year, several of those have actually slid into the Q4. So nothing structural, still very well positioned there. Growth continues to be solid. And as we look into the fourth quarter in our order book, particularly around bioproduction, you'll see, I think, a return to kind of the levels of growth that you would expect in that region.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [6]

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Okay. And then lastly, just hopefully a quick one, but how much of the EBITDA being lowered is FX versus accelerated growth spending versus the lower organic growth? I know you flagged already growth spending.

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [7]

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Yes. I mean if you look at it, if you're looking at the midpoint, Tycho, we were at a $1.050 billion midpoint in the prior guidance. So we're $1.030 billion now, so call it $20 million. Of that $20 million, $15 million is really the Q3 results that we just took you through. And the remainder is mostly FX for Q4. And otherwise, we're pretty in line with what we've talked about before on Q4.

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Operator [8]

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And our next question comes from the line of Derik De Bruin from Bank of America.

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Derik De Bruin, BofA Merrill Lynch, Research Division - MD of Equity Research [9]

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I just wanted to follow up on Tycho's question on EBITDA. I mean this is the -- I realize that there's a lot of FX and mix associated with it, but I -- the question I wanted to focus on is it's been a little bit more volatile than even we had thought given our experiences with [JB Barr] and certainly relative to where the IPO model was. I'm just curious. What can you do to sort of help smooth out the EBITDA? And is there anything you can do? And if you also (inaudible) as you look to 2020, are you still comfortable with at least a 100 basis point EBITDA margin expansion next year given the current trends?

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [10]

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Yes. Thanks, Derik. I was having a little bit of difficulty hearing you -- the first part of your question, but if we -- if I talk about the trends going forward -- and you can start with the fourth quarter if you look at our guidance for EBITDA -- it does continue in line with the model that we've talked about. And just to remind you, during the 3-year integration period of Avantor and VWR, we have a high degree of confidence in being able to grow the margins, in part because of conversion on organic growth but also in part because of the synergies in that 100 to 150 basis point range. We did that for the first 2 quarters of this year. We'll do it for the fourth quarter. Third quarter was, for the reasons we've talked about, a little bit of an aberration. As you head into 2020, that's the third year of our 3-year integration. And while we haven't finished our planning yet for 2020, I would expect that we'll adjust the overall baseline to reflect 2019 actuals, but the growth algorithms on organic growth as well as margin expansion, delevering and so forth still remain intact. Can you help me, can you take me back to the first part of the question?

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Derik De Bruin, BofA Merrill Lynch, Research Division - MD of Equity Research [11]

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No, that basically covers it. That's what -- you got what I asked from the first part on it. I guess the -- another question I just wanted to bring up was on you're seeing some good pricing gains. And I'm just wondering how sustainable those are. I mean you're seeing a little bit better price than even I would have thought you had. Can you talk about what you're doing to sort of maintain that?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [12]

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All right. Derik, as you look at the impact of pricing relative to volume, I think the third quarter played out plus or minus what we've seen in previous quarters, which is to say that we strive to modestly offset the COGS inflation that we do see in kind of more transactional part of our portfolio. And then on more of our proprietary products, which tend to have more of a value-based pricing approach to those, nothing really new to report there. So I think as we look at the contribution of pricing in the quarter, we call that out only to indicate that we continue to execute our model that we've had in place for quite some time here. I don't think anything unusual to note there, Derik.

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Derik De Bruin, BofA Merrill Lynch, Research Division - MD of Equity Research [13]

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Great. And just one other quick one. If you look at -- if you back out the onetime and proprietary products, what did that grow in the quarter?

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [14]

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Yes. If you -- we were looking at the math on that this morning, where if you take the impact of the science and education piece out of it, we would have been strong mid single-digits. Like 5% to 6% is what you would have seen, which certainly is a tad better than what you -- what we would have had on third party. So the -- we think the algorithm of proprietary growth relative to third-party growth still remains intact. And that is a tenet of our baseline expansion.

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [15]

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I think, Derik, it's important to point out, when we look at the proprietary materials part of our portfolio, in large part, you're talking about our exposure to bioproduction where most of our solution is manufactured from our own technologies. And then our exposure into the health care space with our medical-grade silicone platform is also an important part of that algorithm that Tom mentioned. And to Tom's point, those end markets for us continue to be very robust. We continue to see strong double-digit growth in our bioproduction platform led by more than 20% growth in our single use platform. So I would say it's important to recognize that the proprietary materials part of our portfolio does influence margins to a large extent, as we've laid out today. And a core part of that business continues to run at a very high level. And save the one-off here in the science and education business, we talk about another really strong quarter.

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Operator [16]

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Our next question comes from the line of Jack Meehan from Barclays.

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Jack Meehan, Barclays Bank PLC, Research Division - VP & Senior Research Analyst [17]

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I actually wanted to follow on that last point. Just as we look at the fourth quarter guidance, it looks like around 5.5% organic. What -- are you expecting proprietary to bounce back? And Michael, can you just spin off that point related to maybe some of the proprietary products across J.T.Baker and NuSil? Just could you maybe -- how did they perform in the quarter? And how are you feeling about that going into year-end?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [18]

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Right. I guess that's a good place to focus, Jack. When we look at the inferred Q4 performance, obviously you see strong top line or return to kind of the normal margin expansion in line with our long-range targets. And then underneath all that, in order for that to happen, you're seeing a bounce back in proprietary materials. Probably right to think about that in the high single-digit growth levels for Q4. And that is a part of our business. We talk a lot about the limited visibility we have overall to our order book. That proprietary materials part is a -- and particularly in our bioproduction space, an area that does have a little bit longer lead times associated with it. So as we sit here in the first week of November, we do have fairly good line of sight to orders that we would have through the end of the year and are comfortable in kind of the guidance that we've put out for that aspect of the model. When I look into Q3 specifically around bioproduction, I referenced the strength of our J.T.Baker brands in our bioproduction chemicals platform. The single use platform continues to grow well into the double-digits and well beyond, I think, any kind of normalized market growth rate for this space, which I think speaks to our global presence and the success that we're having in growing that part of our business. But you mentioned the NuSil business. I mean in Tom's remarks he did reference a bit of a pullback in that part of our portfolio as it relates to the -- our health care business. And that's another production-oriented platform that from quarter to quarter can have a little bit of volatility to it just given the production cycles and inventory balancing that our customers would go through. And in that particular platform, Q3 a year ago was the high watermark. I think we grew that platform 25% a year ago, so you see a bit of a more normalized environment in the third quarter this year. The comp loosens up a bit, and we see structurally a return to normal growth in that end market as well.

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Jack Meehan, Barclays Bank PLC, Research Division - VP & Senior Research Analyst [19]

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Great. And then in the slide deck, I really like the EBITDA bridge on Slide 8, but the one thing, I guess, that stood out to me was that net productivity was only $0.5 million in terms of the year-over-year contribution [in that]. I know you're at $247 million of run rate synergies. You can annualize some of these as you go into the numbers, but how much -- as we exit 2019 and go into 2020, can you give us a sense for how much is left in terms of the potential to expand margins based off synergies?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [20]

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All right. So I think I'll provide a little bit of a high-level cover for your question there, and Tom will give you a specific walk on that net productivity element of the bridge. We're still very confident in delivering the $300 million of synergies that we had outlined at the beginning of the integration of VWR. We're run-rating nearly $250 million at the end of the quarter here. And as we look forward into next year and the individual programs that are in line to get us to the $300 million, I would say we're very, very confident about that. One important point to note: That program is comprised of literally hundreds of individual projects, some of which are driving top line revenue, some that are driving reduction in COGS, some that are more SG&A-driven. So you're going to see the impact of that $300 million scattered throughout the P&L. And as we look into the balance of this year and moving into next year, you'll continue to see a step-up in the contribution from that program. Now what we're reflecting here in the bridge, and Tom will walk you through it, is just kind of a netting of -- on the COGS side, of near that -- the fixed cost side of things, how that productivity plays out in a quarter.

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [21]

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Yes. So Jack, just to get right to the productivity number that you saw there. I mean it does look a little measly in the walk, but it really is a reflection of some very strong performance on the value capture. I mean there have been -- this has the SG&A synergies and productivity that we delivered in the quarter, and it was approaching $10 million is what I'd say. And there's additional synergies and productivity that's embedded in the price/volume line for the part of the value capture and synergies that are in the operating piece of the business, but just from an SG&A perspective, in this net productivity you've got $10 million offset by some big investments. We made investments in Asia in particular as we're continuing to invest in feet on the street and in laboratory capabilities. And we've also got some additional investments elsewhere in the enterprise, just growth-oriented R&D kind of investments. And you had a little bit of inflation in there as well from a year-over-year perspective. So I expect the -- that bar to get bigger as we head into fourth quarter and into 2020.

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Operator [22]

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Our next question comes from the line of Vijay Kumar from Evercore ISI.

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Vijay Muniyappa Kumar, Evercore ISI Institutional Equities, Research Division - MD [23]

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Maybe I'll start with this Q4 5% or 6%. Just given Q3 was a little bit light, maybe talk about some of the drivers here. I know the comp is easy for Q4, but ex the comp, anything that we should be aware of, the confidence that you have on the 5% to 6% for Q4?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [24]

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Yes. Vijay, thanks for the question. I think when you -- it's important to kind of ground it in Q3. I think you're looking at a quarter here that really didn't want to be 5% on its own absent this point-in-time issue with the science and education customer that doesn't repeat going into the quarter. So you're looking at a normalized mid-single-digit growth as a launching point from Q3 going into Q4. The comp does pull back a couple hundred basis points, but we've had a number of recent contract wins. We've got, obviously, visibility, as I referenced earlier, into the campaign schedules of many of our large bioproduction customers, especially in Asia, which we'll print into the quarter here. So as we look at kind of a deferred Q4 here in that 5% to 6% range, it also has the embedded or implied kind of normal year-end budget flush that we would see in our consumables business. And so I think we're comfortable with the trends that we've seen exiting September. Early read on October would be supportive of the guidance that we have in-line here and then just round it out with a pretty robust order book for our bioproduction business.

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Vijay Muniyappa Kumar, Evercore ISI Institutional Equities, Research Division - MD [25]

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That's helpful. And maybe one on free cash flow, Tom. I think the presentation had you guys delevering to sub 4x end of fiscal '20. You're at 4.8x right now. I mean basically, with $550 million of free cash guidance for the year, this is implying your free cash flows should grow north of 40% to pay down an incremental billion of debt between now and end of fiscal '20. Is that -- does it not make sense, your free cash, $550 million for '19, that should be [carrying] at 40% or growing 40% for next year?

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [26]

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So we -- you have to factor in the EBITDA growth that we'll get as well on the delevering. So I haven't done the math on that, but it is a combination of the growth in the EBITDA as well as the continuing -- continued servicing on the debt that we'll get.

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Vijay Muniyappa Kumar, Evercore ISI Institutional Equities, Research Division - MD [27]

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That's an impressive free cash flow growth number, guys.

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Operator [28]

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Our next question comes from the line of Brandon Couillard from Jefferies.

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Brandon Couillard, Jefferies LLC, Research Division - Equity Analyst [29]

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Mike, if you look to the industrial markets globally in the third quarter, could you just kind of unpack the various subsegments globally, particularly on the more cyclical, say, chemicals and industrial side and what you're embedding for that market in 4Q?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [30]

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Right. So just maybe to provide a little bit of context here. Roughly 25% of our revenue would have exposure into this industrial end-market but in a very fragmented way. We're going to serve lots of different applications, whether that be aerospace and defense, the semiconductor space, food and beverage, oil and gas, with no end-markets representing more than kind of low single-digit percentage of our overall revenue. And as we have been signaling for most of the year, this part of our business has been relatively soft to negative. And we certainly haven't really seen a significant change in that trajectory in the third quarter, and nor are we anticipating or relying on any significant pickup in that -- of those end markets in the fourth quarter. There are a couple of pockets of bright spot for us. Our exposure to the aerospace and defense end market is rather unique in that we're spec-ed in much the same way you would expect us to be spec-ed into a biologic drug with a very specific specification on a long-term platform. That is growing, certainly grew in the third quarter and will continue to grow going into the fourth quarter. The semiconductor space is another important end-market for us. And we've seen the business in Asia slide for most of the year, starting to moderate a bit in the third quarter, I would say. And we feel like we've probably bottomed out in Asia in that end-market and see the signs of a little bit of an uptick, nothing that will drive the results in a significant way but certainly a glimmer of hope that things have likely bottomed out there. Europe, when you look at an impressive print there on the quarter of 4.5%, it is still 100 or 200 basis points below where we had been running earlier in the year. And I would say, if there was one change I would point out, we did see kind of the industrial end-markets in Europe start to slow down a bit in the third quarter. And I think, when you look at a 4.5% print, it obviously demonstrates the exposure we have to biopharma in Europe, but it also does reflect a little bit of a weakening environment in Europe across that industrial sector, particularly as it relates to capital expenditures. And if you recall, roughly 15% of our portfolio in the equipment and instrument part of what we offer is going to be subject to our customers' capital expenditure programs. And certainly saw a tightening of that in Europe. We were off in the quarter low single-digits on that platform and see that kind of moderating here through the fourth quarter, so I would say continued weakness with maybe a couple areas of bright spot. And I would say Europe had a few more headwinds in the third quarter than what we have seen up to that point in the year.

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Brandon Couillard, Jefferies LLC, Research Division - Equity Analyst [31]

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Appreciate that color. And then Tom, just in terms of the guide, you're trimming the EBITDA a little bit for the year. Just curious if -- but holding EPS. Just curious if there are any changes below the line in terms of net interest and other or tax for the year.

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [32]

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Not really. I mean when we put together the original guide, we had some assumed levels of interest expense. We've done a little bit better on that as we progressed through the year. I mean we had repricing in the middle of the year that's helped a little bit. We've also -- the IPO was a little bit bigger than we had modeled. So between those two, we're getting some favorability on the interest line. Taxes will be pretty much in line with what we modeled out in that 30% range. As I talked about, as we look forward, tax, I mean, that's certainly an area of opportunity for us. And we're making good progress on some of the things we need to do to bring that kind of rate down to the levels I have talked about before, but overall it's not a significant change other than the factors I mentioned on the repricing and the IPO signing.

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Operator [33]

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Our next question comes from the line of Doug Schenkel from Cowen.

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Doug Schenkel, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [34]

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Maybe to start with a, I guess, sort of a high-level question. As you noted in your prepared remarks and as we've covered a bunch of times already over the course of this call, you had some onetimers and, generally speaking, a tough comparison relative to the norm in the quarter that depressed organic revenue growth relative to recent trends. That said, it does seem like something surprised you in the quarter given that you cut full year guidance. I know that's basic, but I just want to make sure that's fair. And building off of that, probably more importantly, even if something changed relative to your internal model for the second half of this year, is it fair to say that your 5% to 8% long-term revenue growth guidance is very much intact at this point?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [35]

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Yes, let me take that question. I think your observations on some of the onetime nature of the results that we saw here were somewhat to be expected. Certainly the tough comp was known. Certainly kind of a shifting of revenue from Q3 to Q2 from this science and education customer was known. What was not known is -- on that part of the business -- was the relative level of inventory that they were carrying and the kind of the volume that didn't repeat in the quarter. So we knew that there was a pull-forward of some of the volume, but there was some lack of transparency on just how much inventory that they were carrying and, as a consequence, volume that wouldn't repeat in a quarter. The other dynamic that we didn't anticipate going into the quarter -- and this is actually relatively normal for that end market -- but in the health care space, relatively limited visibility into inventory through the supply chain. You do have relatively volatile production schedules and coming off a quarter where we had 25% revenue a year ago, knowing at some point that there would be likely some inventory taken out of the value chain, the timing of which is very difficult to predict. And unfortunately, it looked like more of it came out in Q3 than what we would have anticipated. So those are probably the 2 things that I would point to that surprised us a bit on the quarter. Relative to kind of our longer-term guide, absent those 2 factors, we had a great quarter: our consumables business holding up in the mid-single-digit levels, our bioproduction business holding up in the low double-digit range. This model is really built to deliver over the long-term on a sustainable basis mid-single-digit growth, with the embedded power on various quarters, as we've demonstrated, to go even into the a high single-digit range is very much intact. And you see that in the optimism we have here around our fourth quarter.

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Doug Schenkel, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [36]

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Okay. That's all super helpful. And maybe if I could just slip in one quick follow-up. On tax rate, you came in well below expectations in the quarter. How much of this was a function of timing or something else? And I guess, as we look ahead, do you still expect 2020 adjusted tax rate to be in the 26% to 27% range? Or are you seeing something as we sit here today that could drive that even lower?

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Thomas A. Szlosek, Avantor, Inc. - Executive VP & CFO [37]

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Yes, yes. I think what you're talking about, Doug, just for everybody's reference, is our guide for tax for the year is roughly 30%. We're still sticking to that. The quarter was a little bit lighter in terms of the rate, I think, came in around 27%. That's about $2.5 million of net income, less than $0.01, so not terribly material. And there is really nothing to point to structurally or from a longer-term perspective, but I would say that -- and then repeat what I said earlier that we are on track relative to things that we need to do to get the tax rate lined up for 2020, particularly around the way we're financing our international operations, doing that in a much more tax-efficient manner.

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Operator [38]

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Our next question comes from the line of Daniel Brennan from UBS.

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Daniel Gregory Brennan, UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences [39]

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I joined a little late. I -- the first question was just on AMEA. I know it's a smaller portion of your business, but I know it's an important growth opportunity for you. And the growth this quarter was below what we were expecting. So could you just kind of give us some sense of kind of what the trend was in the quarter? And also, as we look out, what's the right kind of growth rate to expect for that geography for you? And then I have some follow-ups...

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [40]

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Yes, we did cover that. Yes, we did cover that question earlier in the call here, but just to reiterate the key points from the answer we gave there: Obviously it's a relatively small or modest revenue base for us in Asia, roughly 5% of our overall revenues. And unlike the other 2 regions that we serve, it's disproportionately oriented towards our production customers and then naturally the exposure to their campaign cycles. So we've had a number of really important wins in the region this year. It just so happens that last year was probably the high watermark for our bioproduction business in that region a year ago, so very difficult comps. And a number of those campaigns actually slid into the fourth quarter for this year. So nothing particularly structural, and the business continued to perform well. It was certainly muted by downside in our electronic materials platform, that continues to be negative, but long-term, we would expect that part of our business to grow at least in the low double-digit range for the foreseeable future.

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Daniel Gregory Brennan, UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences [41]

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And then just within biopharma there's been kind of varying degrees of kind of growth this quarter from your peers across the different subsegments within biopharma, but just I know the growth this quarter was still positive, a little bit lower than what it had been. Just can you kind of remind us of kind of your split within biopharma between the bioproduction, which is obviously robust, and other areas and how we think about the trajectory of biopharma in Q4 and beyond?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [42]

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So biopharma for us is roughly 50% of our revenues, so obviously it's a critical end-market for us. And we're excited about the momentum that we have in the business. We highlighted a number of customer wins that we had in the quarter, which would be a follow-on from a number of specifications and wins that we've had throughout the year. So really great momentum there. We're going to serve biopharma across the workflows, starting in the research and discovery phase, all the way through to the production environment. As a rule of thumb, you probably wouldn't be too far off to assume roughly 2/3 of that revenue is going to fall into the laboratory and research and discovery phase and somewhere in a range of 1/3 of the revenue falling into the production environment. And clearly, the growth in the production piece of that is going to be a bit more robust. I think, if you look at and triangulate most of the market data points about production growing high single-digits, low double-digits, just given our portfolio, our exposure globally, we would expect to do at least in line with that, if not slightly better than that.

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Operator [43]

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Our next question comes from the line of Erin Wright from Crédit Suisse.

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Erin Elizabeth Wilson Wright, Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst [44]

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Can you speak to some of the nature of those contract wins in the quarter? I guess, what drove those? Was it the integrated offering that contributed to the wins across CROs as well as in biopharma and the extensions there? If you could speak a little bit more to those, that would be great.

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [45]

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Yes. No, we're always excited to speak about some of the success that we're having. We won't get into any specific customer detail, for obvious reasons, here, but when I look at the success that we've had in defending our accounts as well as winning new accounts across biopharma and across education especially, it's been a really successful year. And when I speak to our customers on the back end of these discussions, 2 or 3 things seem to emanate with them. One, the power of our integrated offering is certainly unique for them. And as these 2 platforms have come together, we're able to offer them a much more significant solution today than we ever have before. And you see that in the kind of share of wallet that we're able to gain with some of these accounts. Our global exposure is important. We referenced in our remarks an example of a customer that we've historically only served in Europe, but as we have built out our capabilities, especially in Asia, but also building on our presence in the Americas, they stepped up and awarded that business to us globally. The CRO space continues to be an important driver of growth for us. We had a number of important contract wins in the quarter in that space. And then playing on a theme that we've been running now for multiple quarters, we continue to build momentum in our higher education portion of our business in the Americas. We had and we have, as we've discussed in other forums, an exclusive relationship with a consortium organization that a lot of the universities in this part of the world would buy across. And given that position as well as just the focused efforts that we've been driving, we've seen a number of important contract wins in the higher education space this year.

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Erin Elizabeth Wilson Wright, Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst [46]

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Okay. Great. And then digging a little bit deeper into the VWR synergies, I guess, can you give us a geographic update on sort of productivity and other initiatives there? Specifically in Asia. I know that was an area that you highlighted with the IPO, as far as the opportunity with VWR synergies, as well. Is that all still intact in terms of the prospects there?

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [47]

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Yes, it is. When we look at synergies kind of 2/3 costs, roughly 1/3 commercial synergies, a good bit of those commercial synergies actually play out in Asia as you're describing as we integrate the VWR portfolio across, in that case, what happens have been the legacy [of on board] infrastructure. And we continue to invest. And you see that in some of our SG&A numbers and other co-operating expenses, whether that be in sales reps or marketing resources or we're commercializing a new application center that we'll open here in a few weeks in Shanghai. So we'll continue to build out a supply chain to service that and then to be able to capture those synergies, but they definitely -- as we see out over the long-term, a region that will be growing double-digits in part due to these synergies.

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Operator [48]

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Thank you. I would now like to turn the call back over to Michael Stubblefield for closing remarks.

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Michael Stubblefield, Avantor, Inc. - President, CEO & Director [49]

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Yes, thank you, everyone, for participating in our call today. We certainly appreciate your support of Avantor.

As we've talked here, we had a bit of noise in the quarter from some prior year one-offs and mix and foreign currency headwinds, but we're pleased with the underlying growth that we did generate, the strong cash generation; and excited about the optionality that the deleveraging trends that we have will provide for our business going forward. Biopharma, certainly our most important end market, continues to grow strong. And overall we exited September with great momentum that has carried forward into the fourth quarter. And we've talked here on the call today we did see significant customer wins in the quarter, and we're strengthening our overall value proposition by continuing to make strategic investments to better serve our customers.

Certainly our operating performance benefited from continued progress in the operational efficiencies and synergies from our integration program with VWR. And overall, we remain on track to deliver the margin expansion and cash flow that's in line with our long-term objectives. As we look at this platform, our business is certainly well-positioned to further enable the innovation and breakthroughs that help our life science customers dramatically improve patient outcomes.

Again appreciate you joining our call today. We look forward to our next update after the new year and to seeing some of you in person in the coming weeks.

Have a great day, everyone. Thank you.

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Operator [50]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.