Agilent Technologies, Inc. (A) Earnings Call Transcript & Summary

All right. Good afternoon. Thanks, everybody, for joining us. Welcome to Jefferies 2021 Virtual Global Healthcare Conference. I'm Brandy Couillard. I cover the life science tools and diagnostics sector here at the firm. Very pleased to have Agilent with us back at the conference this year. Joining us for this conversation, CFO, Bob McMahon. Bob, thanks for joining us.

Thanks, Brandon, and good afternoon, everyone. Certainly a pleasure to have a chance to talk to you about Agilent and the business going forward.

For anybody that's on the line, if you'd like, please feel free to e-mail me a question that you might have, and we'll do our best to try to work those in. Bob, just to kick off, I mean, Agilent has remained quite resilient in terms of top line growth. From the start of the pandemic, right, you've really seemed to have kind of been firing on all cylinders. As showcased by last week's print, you put up 19% organic growth, which is the best in 10 years. And the 2-year stack was certainly the best ever and well above peers when you sort of strip out all the COVID testing dynamics and those kind of tailwinds. Clearly, end markets are very strong, right? But you've consistently kind of outpaced your closest peers for a while now and seem to be taking share in a few areas. If you can you kind just talk about where you think Agilent has specifically been gaining share? What's been some of the key drivers of that? And how sustainable some of these, I'd say, above industry trends are in your view?

Yes. Brandon, I appreciate the kind of recognition and, certainly, pleased to talk about the opportunities here going forward. And this is really a journey that we've been on for the last several years. And I think one of the things that we've really been focused on over the last couple of years is, one, refreshing our portfolio. And I would say our position -- our portfolio across our various technology platforms is the strongest it's ever been. Couple that with the investments that we've been making in informatics, and I think you've got a really powerful solution, coupled with the execution that we've talked about going forward and really, this focus on faster-growing markets. Mike talks about the Build and Buy strategy, and I think it's really showing up and our increasing focus in these faster-growing markets. I would say, certainly, as you said, we're benefiting from some of the end market recovery. But if we look across our major technology platforms, we believe that we've been outgrowing the market, certainly in LC. Mass spec has been a strong performance across both GC and LC for the last 1.5 years. And now what we're seeing is with the advent of our cell analysis business, that growing faster than the believe the market to be as well. And so I think it's a combination of the new products that we have, some of the digital investments that we've been making around informatics as well as our service and support organizations that have really been able to target the faster-growing subsegments of these major markets and continuing to drive that across the platforms. Now I'm talking about pharma, but I think you can play that in the other markets as well, whether that be our C&E market, the food market, which has really recovered and grown very strongly over the last couple of years. Both of those, we're leaders in and intend to stay leaders in. And then on the diagnostics side, which is another large business, continuing to drive portfolio, whether that be the Omnis platform, our diagnostics business and, obviously, the new acquisition of Res Bio, which I'm sure we're getting into. So I would say we've had a number of different opportunities and really growing in all of our key segments, really driven by that portfolio and then the great execution that the team has done in the field.

I want to drill in on a couple of the specific end markets, coming out of the second quarter, that really stood out to us is surprising, food being one of them, right? Food's grown north of 20% for at least 2 straight quarters. Can you talk about what you're seeing there and how sustainable that is? Is this catch-up demand? I don't -- I'm not aware of any like major regulatory changes or new things like that. Talk about that market specifically and where most of that is coming from geographically.

Yes. We're very pleased with how the food market has performed, and I think there's a couple of inherent tailwinds or drivers here. Certainly, we've had -- we've seen recovery in China as we move from a more centralized model to a decentralized model, and that really started playing out last year, and we've seen continued growth. But what we saw in Q2 was really a broad-based growth across all end markets. Actually, China grew roughly 20% the overall market. Our business grew 22%, so driven by places like Europe and America is really growing, so broad-based across. And I think there's a couple of drivers that are behind this. One is, we are seeing a increased focus and emphasis. I think it's probably a halo effect of COVID, which is around food testing, food safety. I think people are wanting to ensure that the safety of the food that they eat, the air that they breathe and the water that they drink is safe. And then -- so I think you see just a broader, more conducive testing environment. And then I think you're also seeing things like some of the engineered foods, some of the artificial meats and activities becoming a larger piece. That requires an analytical lab not unlike -- what looks like in pharmaceutical. And so you're actually seeing these alternative foods that are coming in that are driving this market as well. And then the third being cannabis, which is primarily a U.S. phenomenon. That business took a little pause and is accelerating again, really, on the back of legislation here in the U.S., but also our workflows and portfolio.

Okay. Okay. If I look at diagnostics, shifting gears over there, I think you grew 13% organically in the second quarter. You mentioned that exiting 2Q, the testing volumes were slightly above pre-pandemic levels. And I think if you look at some of the other players in this space, be it Roche and some others, seem to be signaling that it's still somewhat sluggish, not fully returning. Do you think you're capturing share there? And is there a geographical dynamic behind it?

Yes. We do -- we feel very good about our diagnostics business. So it's focused on cancer diagnostics, which didn't see the strong dip, whereas some of the screening assays where you go for a wellness check and so forth, those things had a precipitous fall off and then are recovering. Ours is more on a diagnostic side, and it didn't show a decline. And we're starting to see it. back. I think it's a couple of areas here, Brandon. One is, if we look at our geographic footprint, we're strongest in Europe in that business and then in the U.S. and have an emerging presence in places like China. And both in the U.S. and in China, actually, we saw the stronger growth in the second quarter. And I think it's behind the expansion of our assay portfolio on our Omnis platform, which is the automated platform that we have around the globe. What we actually saw in Q2 was a resumption of -- actually exceeded our expectations on instrument placements, which had some impact on the margin there. But I think that, that actually speaks to kind of future opportunities, going forward. So I think it's a combination of the market recovering. Now we do believe that we are growing in the tissue diagnostics maybe a little faster than the market has really on the back of that automation in places like the U.S. and in China. And in China, we're woefully underpenetrated. It's a huge opportunity for us when we think about this. And actually, when we combine the opportunities that we have with Res Bio, so they'll have not only tissue diagnostics, but also NGS-based diagnostics, we think that the portfolio that we have is going to be very strong. And so we're excited. We saw that -- like I said, we exited. I would expect Q3 to actually have a very strong performance because Q3 was the weakest quarter last year for our cancer diagnostics business, and then we started seeing a recovery in the back half of Q4. So I would expect strong growth in Q3 across our diagnostics and genomics business really on a function of easier comps and continued market recovery, but it's on the basis of discontinued share gain through automation and the expansion of our assay portfolio.

Got you. The last end market update I want to touch on coming out of the quarter is biopharma, right? I mean you grew 29% there in the second quarter. And it's not like you were lapping an easy comp, I mean you lapped a plus 5%, which is pretty remarkable. Number one, can you talk about what's happening in the small molecule side of that business? And number two, do you think that coming out of COVID, this end market could see a couple of years of accelerated growth or structurally higher growth post-pandemic than maybe we thought about this market previously?

Yes. It's -- we're super pleased with our pharma end market. To your point, we grew 29% in the quarter of a 5% growth last year. And if you kind of bifurcate that business between large molecule and small molecule, both of them had outstanding performance. Actually, our small molecule business, which is roughly 2/3 of it, 65%, grew in the mid-20s in terms of growth, and I'll get back to that in a second. But the area that we've continued to be focused on is kind of the large molecule, and that's where we're building workflows and capabilities around our digital capabilities and the NASD business and cell analysis. And that grew roughly 40% across the business. And so we've been extremely pleased with that. And that, to me, that biopharma or large molecule business, is largely capacity and expansion of capabilities across the supply chains and end markets, whereas small molecule's more a replacement cycle. And so on that capacity side, we do not see anything that should slow this down going forward. Now I wouldn't book 40% going forward on a quarterly basis, but structurally, we do believe that the pharma market, both large and small molecule, is probably a faster-growing market ex-COVID than it was coming into COVID: one, because of the amount of investment that customers are putting into this, as well as government investment around research and some of the new technologies around mRNA and some other technologies, I think you're seeing a real renaissance in building out capacity. And then on the small molecule side, I think what we saw was a couple of years of actually slower-than-normal kind of replacement cycle. So that business had been flattish plus or minus a couple of points. And now what we're seeing is, I think, a recovery of that market to replace because the interesting thing is, if you looked at pill count, which is a good proxy for whether that markets are declining or the health of that perform, it continues to grow. So there's only so much time before you have to go and replenish. And we have a good story there because we're also driving productivity in the lab. And so you combine the instrumentation that we have, coupled with our service and digital capabilities, it allows us to actually drive higher uptime for our customers, which actually improves their productivity and so forth. So I do think that we're going to see faster growth coming out of this and are super excited about the pharma business in general.

Very helpful. Maybe switching gears. I think one blemish, perhaps, you want to call it that, coming out of the quarter was really on the gross margin line, which is a little bit confusing to me. I'd like to get your help and perspective on a couple of things. So gross margins were flat in the quarter even though you grew 19% organically, and they're still down from 2Q '19 levels and the top line is a lot higher, I think 23% higher than it was 2 years ago. You did mention currency being a 30 basis point bad guy against you. But can you walk through some of kind of the other components to gross margins in the quarter?

Yes. At the highest level, I think what we're seeing is our gross margin came in the way we expected it to, at least internally as we were thinking about this. Seeing a couple of various pieces, and we can kind of dig into kind of the elements, the first piece was this 30 basis points hedging, which is kind of a timing thing that should come back to us going forward given the strength or the weakness of the dollar. And then what you're seeing is actually a mix shift with our businesses that are growing faster, places like NASD, ACG businesses and so forth in general are actually becoming a bigger and bigger piece relative to a couple of years ago. And so what you're seeing is pressure on the gross margin side, offset by really nice leverage on the operating expense. So think about -- there's a couple of ways, so roughly 30 bps of margin associated with FX, there's probably about that same on a mix perspective. And then we did have increased activity. I talked a little bit about this in the call last week, where as labs are opening up, our field service engineers are visiting more facilities, which we actually see as a good thing in terms of starting up equipment activities happening faster, shows up as higher costs in the COGS line. Some of that wasn't there in Q2 of last year, so probably our most difficult comp, and we're seeing that coming through in higher costs and gross margin side. But again, it drives a very nice profit. And so we feel very good about it and are continuing to drive efficiencies there, but it's also an area where the mix is going against us a little.

Okay. That service dynamic, does that explain kind of most of the reason that the ACG segment was down, I think, 90 basis points in the second quarter?

Yes.

Okay.