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

Great. Thank you, and thank you, everybody, for joining us today for the Agilent fireside chat. We're pleased to have with us from the company, Mike McMullen, CEO; Bob McMahon, CFO. This will be fireside chat format, so please feel free to send me your questions. You could reach me at [email protected] or you could use the question tab on your conference portal. With that, Mike, I think you have a couple intro remarks to kick us off.

Yes. Thanks, Dan. I just want to say, first of all, Bob and I really appreciate the opportunity today to speak to you and all of your clients, so thank you for this opportunity. As we discussed earlier this morning, Dan, we've just completed our Q3, and it just seemed like yesterday, we were having our earnings call but maybe just a few headlines from that call, and I'll pass it back to you. Q3 was a very strong quarter for us, a continuation of real strength in the business. Core growth up 21%. I think our margin is up 230 basis points, EPS up 41% over prior year, and real theme was broad-based growth across multiple end markets, geographies. And I'm sure we'll dig into some of those details. And the last thing that I'd mention would be as we entered going in the fourth quarter with momentum as we continue to see strong strength in our order book as well. So really pleased with the performance of the team throughout the year so far. And I think we're really well positioned to have a strong close to a fiscal 2021 for us and which will be inclusive of almost $1 billion in incremental revenue over prior year. So with that, I'll pass it back to you, Dan, to see where you and the clients may want to go on the Q&A front.

Great. Well, maybe I'll start off with a question I've gotten recently from an investor. And I'm not sure you'd be able to isolate your growth drivers in this format, but I'll try. So do you have a sense for how much of the upside strength you're seeing might be from a driver like general manufacturing capacity expansion on the part of your customers, in part, due to all the supply chain bottlenecks we're seeing market-wide? Pick your industry, chemicals, fine chemicals, pharmaceuticals, et cetera, versus -- so that is one potential source versus perhaps onshoring and expanding capacity within borders versus perhaps generalized up mixing to pharmaceutical customer bases, et cetera. If it's even possible to isolate, I would appreciate your thoughts.

Yes. It's a very insightful question. I'll lead off with here and then Bob, I'd ask you to jump in as well. So when I think about our business, I could say there's 2 -- let's think about the R&D side of our business and then QA/QC side, which is tied really to production and manufacturing. About -- we're seeing strength in both segments. I would say the R&D really is driven by continuing focus of pharma to invest in the next development of next-generation drugs. And in particular, we've seen with COVID, we believe that the investment levels actually did increase and have a more positive long-term outlook relative to R&D spending. I'd say that the business today is primarily focused on supporting today's production capacity. In particular, in our C&E business, there's been a deferment of replacement equipment for an extended period of time. That now situation has now changed. So I'd say the near-term business is really about supporting the base production capacity with updated equipment to support the QA/QC process. I think we're still early days in terms of some of the activities relative to expansion. We were seeing both in terms of expansion but also early indications. We've talked a bit about this already as it relates to either directly on [ trend ] in the pharma or in the chemical side to find the precursors into that pharma process, bringing those back into -- it's primarily more of a decision of as they develop the next set of drugs, they're going to do more of the ingredients in-country as opposed to importing. But I think that's still early days. And Bob, I know you've taken a really close look at that. But I'd say R&Ds, we're driving a lot of business today as well as replacement. Early days in terms of what we believe is a trend, which is to do -- to change where certain precursors in the pharma and food value chain are done.

Yes. No, you're spot on, Mike. I think that, that's what gives us a lot of confidence about the continued growth trajectory, that it is largely based on existing capacity. I would say biopharma on the R&D side and then increasingly into vaccine and capacity production there, but the large driver is really around the investments that are going into the R&D side of the biopharma business or within pharma, and then as Mike said, the QA/QC. I would say, as we're hearing about things in C&E, that, that is more an opportunity for us going forward because we are seeing the supply chains being stretched. And there is a capacity or desire to increase capacity, and particularly and you're seeing things like inflation around chips in these key areas. Our customers provide raw materials into some of these areas around fine materials, specialty chemicals and so forth, and so they are looking at ways to expand capacity. We're starting to see that in the order book, but it's more future looking. And that's one of the reasons that we think that the chemical and energy business still has a ways to go in terms of the expansion.

Okay. That's a great clarification, and you answered it in a much clearer fashion than I think I asked the question. So Mike and Bob, can you remind me, and we're specifically talking about the analytical lab side of your business, how much of that is R&D-driven versus QA/QC-driven, what the mix looks like?

What, about 40-60, you think, Bob? I'm trying to...

Yes, it's probably in that range. Yes. I mean I think one of the things that we said, if you think about kind of just the overall -- our largest end market being biopharma and one of the things we've been incredibly pleased about our business, both -- this includes the diagnostics business, meaning the API side, what we're seeing is an increase in that biopharma or large molecule exposure, which is probably more R&D-oriented today but has the opportunity to go downstream going forward. And that was probably in the 20%, 25% range 3, 4, 5 years ago of the total business, is now -- and ended up being 36%. And it grew 50% year-on-year; and even if you took out NASD, it still grew 40%. So this is an area that we continue to put a lot of investment in. We just launched 3 new LCs, bio and/or LCs -- or bio LCs in the quarter. Didn't generate revenue yet but a lot of excitement in the field for those opportunities. And I think this is an area where we'll continue to invest and, I think, see strong growth.

Yes. Absolutely, Bob. And again, I think we've talked about this in the past, but investing in the large molecule side of the business has been a major part of our strategic intent for a number of years. And we're now seeing the fruits of that work, so to speak, in what we believe to be really strong growth. And we think we're still -- we still got a lot of runway ahead of us in this space.

So the movement from R&D to a production environment in large molecule is something some of your competitors are focused on as well. How do you feel you're competitively positioned in that move?

Quite well. So we're quite familiar with the dynamics of this market. We've been a big player in the pharma market for years. And how things work on the small molecule side, we see the same thing happen in large molecule, which is a lot of initial work is and focus is on the R&D side. That's why it's very important for you to get a position there because then when you transfer those products into the production environment, you want to ensure that, often, you want to be working with the same technology, same vendor, same equipment. So we think that we're really well positioned to pick up that downstream business. And we also have a number of initiatives to also recognize the fact that the biopharma production environment is going to look somewhat different than the small molecule side, where maybe more at-line, online kind of measurement, smaller batches. So we've been working on this for a while. And that's why we're quite bullish about our long-term prospects here because the fact that we're doing well on the R&D side, we're already very well established on QA/QC on the small molecule side. And we think the business is going to follow there for us in large molecule as well.

Okay. Can you address the strength you've been seeing in small molecule? What's been the driver of that strength?

Small molecule, so one is, I think, you've had -- one, I think what we'll probably talk a little bit about today in some detail is China. So when the 4+7 first came out, a lot of concerns. There's a pause in the business for about a quarter. And I think Agilent was saying, "Hey, don't worry. This is actually a good thing because anything that drives a higher tool count is a good thing for small molecule business." And I think that's been the case. In fact, we were well positioned in the companies that have been winning the tenders. The other thing is our data system, our overlap system is really state of the art. And in particularly in China, there's a lot of greenfield opportunities where new labs are being outfitted with instrumentation, data systems. So I think it's been that combination of continued innovative of new instrumentation, along with OpenLAB. And then, Dan, you noticed earlier I was wearing my CrossLab shirt today for the call. I think we're well positioned. Let's not forget about the services side of what we're doing in pharma in support of small molecule labs as well. So I think China has been a big part of that as well as continuing of the replacement of equipment in our U.S. and European customers, where we're really, really well positioned. And Bob, what else would you add to that?

Yes. No, that's where I was going to go. I think one of the things that we saw, Dan, is probably lower than average in the '19-'20 time frame. This is largely a replacement cycle ex China, where you do still have some capacity expansion, and you can only defer that capital purchase for so long. And we have a very refreshed portfolio of LCs in combination of informatics that Mike just talked about in the service. And I think what we're seeing is, given that the funding environment is very constructive in pharma [Technical Difficulty] the pandemic, and then certainly, this year, we feel very, very good about our competitive position and how we're growing vis-à-vis the market. And we expect that to continue.

And Bob, if I can just add here, Dan, we've talked about this past, our strategy here from the very beginning, it was to come out on the other side of this pandemic even stronger as a company. So we never took our foot off the gas as it relates to investment in our core innovation programs. And now you're starting to see, when the market's turning back on in terms of ability to invest, we're there with a very competitive portfolio and as Bob mentioned, for example, on the bio side, we just introduced 3 new LCs. So we're -- our -- and hats off to our team that they're able to find ways to continue to develop products in this environment.

Okay. So wrapping it up, how would you frame your growth opportunity in the pharma biotech markets going forward?

We're really optimistic about our ability to grow in pharma. As you know, pharma is our largest market already. You're seeing very strong performance from Agilent not only in terms of the small molecule, which has been an area of historic strength, but we've been methodically building a larger presence in the large molecule side of the business. And we've talked a little bit about it already as it relates to liquid chromatography and LC/MS. And we have a broad-based portfolio to really do a great job there on the analytical lab side; but we also have -- and I'm sure we'll get into it in the call today as well, we also have a growing GMP oligonucleotide business, which is tied directly into the biopharma. We've got a -- we have a biopharma services business already on the IHC side and our diagnostics piece. We just announced the acquisition, a few months ago, of Resolution Bio. So you can see what we're trying to do is really build out a stronger position in the whole biopharma area. So we're very bullish about our prospects here. And that's why I think you heard Bob talk about how much of our mix in pharma is now coming from the biopharma side. And it's not because the small molecules shrunk. It's been -- it's just that we've been -- we continue to grow here. We think we're picking up share. And we really like our prospects here. And again, I would not under -- want to discount the fact that service is a big part of that story as well because, as you know, Dan, services is well over 20% of Agilent's business today.

Yes. Dan, just to follow on what Mike was saying, is if we think about -- Mike mentioned the belief that we're coming out of the pandemic stronger, and the numbers kind of back that up. I think one of the areas that we think, from an end market perspective, is certainly kind of structurally a faster growing market today is, in fact, biopharma. We thought that this was the fastest growing subsegment of pharma already at the high single-digit, maybe 10% kind of growth rate. What we're seeing now is, at least in the mid and near term, much faster growth than that from a market standpoint. And given that our investments there are going to continue, we actually see fundamentally that pharma is probably a faster growing market coming out of COVID than it was previously, which obviously puts us in a good position to continue to grow nice after '22 and beyond.

Okay. And I want to touch specifically on NASD, but maybe before we go there, questions are coming in via e-mail. Here's one asking if you've seen anything different of late in China, either from an economic trend or a government policy perspective. Anything new in China diagnostics in terms of tenders or local competition?

Nothing new, but there are clearly macro trends that have been in place for some time and are continuing. And what we're seeing is a continuing push by the Chinese government, where possible, to favor local competition. And I think that's why you really need to make sure that you have -- and is not a material impact on today's business because the Chinese competitors lack the equivalent capabilities. I'd say the other thing is there's a push to have more of products purchased with China content. That's why it's really helpful for us to have that -- our strong footprint of manufacturing that already exists in China. We have 2 significant manufacturing sites in China already. And as you may have seen in our recent earnings call, we announced the expansion of production of our genomics portfolio in China as well. So these aren't new trends. They've been there for a while. And Bob, I don't know if you -- if there's anything else that you'd just add.

Yes. The only thing I would add, obviously, we're watching the economic parameters as everyone else is. And the question may be coming because there's been a slight dip in PMIs over the last several months and so forth in China. And to be clear, we haven't seen any slowdown. Again, still see our orders and the funnel is continuing to be robust. I think our portfolio actually meets a significant need in the Chinese market across multiple end markets. Each market is probably recovering differently. The academic market is still probably the slowest to recover. Pharma has always been strong and so forth. But to be clear, we're expecting, incorporated into our guide for Q4, high single-digit growth off top of a 13% growth last year in Q4. And so we feel very good about our business in China.

In fact, our Q3 -- if I recall correctly, Bob, our Q3 stack growth rate was higher than Q2. So it is part of the acceleration of growth on a stacked basis.

Yes, that's right.

Okay. So another question via e-mail. Is the dynamic in the chemical and energy end market something that's more transient as spending and capacity expansion catches up? Or have we rebased structurally higher in this end market?

Dan, I've been fairly cautious about my commentary over the last probably better part of 2 years about C&E. You're not going to hear a different tone from me. We think that it's still early days, but we think momentum here in C&E is going to continue. There's -- and I think it's being driven by 2 things: one, as Bob mentioned earlier, deferment of needed capital replenishment. We're now seeing that occurring as our customers are more confident about the economic outlook and end markets, and so they need to support the growth. They need to have latest equipment. So there's been a deferring of capital replacement. We're very well positioned in this marketplace. We're probably 2x the #2 competitor in this space. So we have a broad-based portfolio. So -- And like I said earlier about going out of the pandemic even stronger on the back side. Right before the pandemic started, we just completed the refresh of our flagship GC portfolio. Customers were very interested in the product, and then everything stopped, right? Now it's turning back on. So I think we're really -- we think we're early days of what we think will be some solid growth here for quarters to come. Now the long-term growth rates of this market aren't in the neighborhood of a biopharma end market, but they could be healthy. And you have to also keep in mind, there's the great leverage we get because these core technologies we have, like liquid chromatography, are also used in the C&E space. I mentioned the replacement piece, but I do think we see -- we also are expecting some level of capacity expansion given the conversation we had earlier on onshoring and just the fact that the economic growth is looking different. And then in places like China, they still believe -- not still believe, but they're on a path to continue to have -- be self-sufficient. So though we continue to be -- capacity expansion in that part of the world as well. And Bob, I know that you've looked at this thing really closely because this is really an important part of the Agilent story right now and going forward.

Yes. No, I think you said it well. I think the one thing is we're extremely well positioned in this market as you mentioned, and I think one of the areas of continued opportunity is that leverage piece. But if we think about our -- we talked about Agilent CrossLab as a service component, this is an area where we're underpenetrated. And I think there's an opportunity to continue to grow above market really on the back of our services organization given that we have such a large installed base. They're, largely today, self-maintainers, but as we -- as the instrumentation gets more complex, our software and services allow them to actually see the productivity and so forth. We're driving -- pharma has been the lead in terms of being able to improve that connect rate and so forth, but there's a huge untapped opportunity, I think, there within the C&E market for us to be able to grow faster, I think, than the overall market. But that's going to take -- and that's a multiyear opportunity, I think, for us.

Okay. Another question via e-mail. Can you break out what level of growth over the past few years you think might be attributable to share gains and what gives you [indiscernible] continued share gains as competitors seem to be doing well, getting stronger?

I don't know. I don't know how we work the math on that. I mean, the [Audio Gap]