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

Yes. I think maybe just one last thing on this because that's intangible, but I think extremely important because this is a strong competitive advantage for us. And so having a trusted adviser that -- when you know when you call, let's say, an instrument goes down and you can go and fix that instrument, that's a very sticky business. Think about -- I'd like to think about it as a mechanic or a plumber. If you have a plumber or a mechanic that you can -- you'll take your car to each and every time something needs to be done, that's hard to displace and so the more instruments we have under contract, I think the better it is and the more sticky that customer is and actually it creates opportunities not only to improve our products but also get more competitive wins because you use them as benchmarks for the next customer and so forth. So I think it's a real competitive advantage for us.

Got it. You kind of addressed already some of my questions on the growth side. But on the margin side for ACG specifically, it did about 25.5% EBIT margins in fiscal '22. We've always thought about this business as sort of a long-term potential like a 30% EBIT margin business. Maybe help us understand some of the drivers behind further operating margin expansion as it relates to ACG. Is 30% a realistic target? And is it attach rates? Is it geographic expansion? Like what are some of the drivers of -- for ACG margins specifically?

Do you want to take that, Mike? Yes, yes. So I think -- bottom line, I still think that 30% is achievable. And I think it's a combination of a couple of things. The attach rate will really drive that. So you think about its attach rate and digital capabilities. And so if you think about attach rates, the more you have attach rates, what's the #1 cost or the #1 expense and unscheduled service call, somebody who has to go out to a system. But if you have predictive capabilities to understand or you are able to actually service more instruments with that service call, you get tremendous scale. And then I think -- so the more instruments we have under contract, the more scale you're going to have to be because you don't have to add more people. And then you couple that with the digital capabilities. Mike talked about this, the more you can actually solve without having somebody go out and get our customers comfortable with chatting with somebody online, one of the benefits that we saw in -- during COVID was because you couldn't travel. Sometimes these folks are doing highly technical experiments that you have to get a specialist that may not be in the territory. So what they ended up doing post -- pre-COVID was they'd fly, take 2 days. Now you can put them on a Zoom call, instantaneous help supporting the customer. If that helps, the customer increased it, but it also helps us from a cost perspective. So I think continuing to invest in these digital tools, WeChat is a great example of that in China. And then just building up the scale through the attach rate is going to help us drive that capability or that scale.

Got it. Maybe pivoting to 2 kind of exciting areas of your business, ASD and cell analysis, they've been key growth drivers for you, and now they're getting some scale as well. Maybe talk a little bit about NASD first. When you think about sort of the move from preclinical to commercial and the boost in volumes, and you guys have been building capacity and that's been the only constraint. It hasn't initially been demand. But as you think about scale and the need to provide that scale at commercial -- for commercial capabilities, how are you thinking about sort of your overall bioproduction from NASD type business when you think about sort of expanding outside of siRNA and other areas? And how can Agilent play a role and how important scale will be into that?

Great questions. And just for the audience, when we use the word NASD, we're talking about our GMP-grade oligonucleotide business. And right now, we are the leader in siRNA and all the oligo drugs on a market that used in siRNA are being supported by Agilent. So -- and you're right, it's been mainly a capacity constraint. But as we continue to build out capacity, we've got another production line coming online later this year, we can talk more about that. That business, I think, crossed over $300 million or so last year and we're going to be bringing on another 150 or so of capacity. We don't see a lot in '23. But we also have really special capabilities around GMP-grade guides for CRISPRs were really capacity constrained. So I think we think there's opportunities for us to not only continue to meet the increasing demand for SiRNA, but to play more broadly across that space into antisense into GMP-grade CRISPRs. And I think there's a real role here for Agilent play because of the reputation we have in the marketplace, which is how are we able to overtake and become #1 in our space, which was -- not only do we have these great facilities, but we have a great technical team. And in the way this marketplace works from our perspective is not simply a customer handed-over recipe to say, go make this, we're actually intimately involved in their development activities. And we've got a reputation in the marketplace of a company that's customer oriented, easy to work with, highly technical and really there to ensure the customer success. So I think that's the kind of things that get us really excited about this space because -- and then the market itself is just continuing to grow. And when we first started in this business a number of years ago, there was questions about would the science actually prove out to. And we're seeing really good indications from our pharma partners about the therapies that come on market, they're going to service even broader patient populations. And ...

Yes, I was going to say, I think that that's where we get really excited is when we look at the targeted disease states that are developed right now. They're much larger targeted populations than the current products that are on market. And I think that, that helps us because people -- you hear about all of those production and so forth and many people make them, but they don't make them at scale. And so our ability to make these kilogram scales, commercial volumes, I think, is best in the industry and I think are continuing to push that envelope and invest gives us a big opportunity as the disease therapeutic areas continue to be larger and larger.

And it's one thing to do Aligos for research, another thing to do for GMP. And you have to have the right systems and capabilities around regulatory as Bob has mentioned, one of our competitive advantages to be able to produce at scale in GMP side. So we're feeling pretty good about our position in the marketplace and we're also feeling increasingly confident about the uptake of Train B when it will come online for us. As you may know, we had some challenges relative to COVID where a lot of the skilled tradesmen where we just couldn't get them. They just went away because they're ill, supply chain issues, that's all behind us. So we still have work to do. But as Bob and I have been saying today, it's under our control.

And I know this question has been asked a lot this morning in other meetings, but just kind of remind us on the $300 million run rate as you exited your fiscal year, you're bringing on Train B $150 million. How should we think about the phasing in of that new capacity as it relates to the run rate for '23? And then on the cost side, how should we think about the cost side?

Yes, it's a good question. So our expectation is by the end of the fiscal year, we will be at kind of the capacity run rate. But I think if you thought about that in $150 million run rate and created a 1/3 of that, that's probably a good number for FY '23. We're assuming double-digit growth happening and then obviously, the full complement happening in '24. So going on a $450-plus million book of business in '24, we are going to expect to see start-up costs probably into the tune of $10 million to $15 million in 2023. That's built into it. It's baked into our guide, probably starts in 20 -- in the second quarter as we're training, bringing on folks for training on the floor. And we'll have more of the incrementals look very good, but you've got a fixed cost of turning on the light, so to speak. And then going into '24, then you would have that run rate being very accretive to the overall company.

Got it. And then just on the cell analysis business, a similar question. I mean, you built this business over a series of transactions over sort of the last, call it, 7 years, built it into about a $375 million business growing around 25% plus. As you think about scaling that business as well and competing in that business, how do you think about Agilent's position today versus where it could be? And how do you think about investments both organic and inorganic?

Yes. So thanks for that question about it. In fact, we're really delighted. This is an example of our buy side of our growth strategy and through a series of really targeted acquisitions, I think we built a nice business. And I think, first of all, it starts with the kind of view of our portfolio, right? So we have some more traditional tools in the cell analysis, like plate readers, but we also have leading cutting edge where nobody else has the live cell analysis, for example, some of the imaging platforms. And so we think we have the scale to compete. And what we're after and we're going to be driving and why we're going to continue to win is to be able to integrate these tools in common data formats to be able to have the integrated data analysis because what you would find as you go into these laboratories is they were using different equipment from different vendors, and we're now going to have integrated workflows. That being said, this will be an area that we could see not only increased organic investments, but there are other things we can do inorganically here as well. So that's an area that we'll continue to look at for opportunities.

Got it.

And I think probably the same thing holds, I did mention earlier when you're talking about the NASD business, there could be inorganic plays there as well.

Got it. Just shifting a little bit to the risk side of the business, as we see them at least and would love to get your view on it, Europe is kind of still high on our list, given the energy situation over there. You've called it out over the last couple of quarters as being sort of on your watch list. You grew 14% in fiscal Q4 in Europe, so it hasn't shown up yet. But it's something that you've obviously talked about and is concern of -- how do you see sort of in Europe the best of your ability playing out over the course of this year, particularly if we get a mild winter? Has there been some sort of subdued spending from some of the customers over there we could see return in the back half? How are you thinking about that?

Yes. No, so great question. And I mentioned earlier that we've now been able to see how the business finished through calendar year 2022 and haven't seen it yet. It would be the same statement around Europe. I think -- but I think we still have to be cautious there because there's just so much macro noise around the economic impacts and the customer's ability to invest when they're dealing with higher energy input costs. That being said, if things do continue in terms of moderate -- more mild winter, if energy prices aren't at the escalated levels that people had anticipated, that could be that positive for us. We're not ready to call it but if that situation would develop with this thought as we set up the company, for '23, what we knew was pointing to slowness in Europe. We haven't seen it yet, but those macro win headwinds that people were -- have been concerned about haven't also dissipated either.

Yes. Got it. In regards to China, obviously, some big policy changes there when it comes to COVID, which given the disruptions that you saw earlier this year which -- I have to say, you probably had the most significant disruption during calendar Q2, it's still [indiscernible] number, so it was very impressive. But -- so we're probably not going to see that from a government policy standpoint. However, there still probably will be disruptions because of COVID in China. How are you thinking about the opportunities in China under the sort of the new non-zero COVID policy? And what you've learned this past year in terms of how to adapt to that environment?

Yes. Thank you, Matt. First of all, thanks for the recognition on how we handled '22. I think sometimes we may get lost in the quarter-to-quarter variation, we did 18% growth for the year in China. And then as you mentioned earlier in our second quarter, we pretty much were shut down in Shanghai for a large part of the quarter all of April and a good part of March. And the team did find a way. The business has never lost, it was always deferred, et cetera. But in terms of learning, I'll get to the impacts of how we see the change in policy. In terms of learning what we've done since then is really made sure we opened up multiple entry points into the country. So what we saw was if there was a lockdown, it would be in one particular area, but we over-indexed to Shanghai. So what we've done is we've opened up a lot more importation routes into the country through different ports of entry. We've also put more -- and you probably saw us a little bit in our working capital, we put a little bit more in terms of consumables and support parts in, what we call, forward stocking locations so that you weren't dependent on a support part coming in from the U.S. or Germany or some place to get to our service engineers. So that's kind of things we've done to sort of mitigate the risk. Relative to the change in policy, we were really delighted to see that because it's -- now the situation is more under control, we've actually already weathered one of those storms already without any impact. We've seen a lot of -- we saw the wave kind of go through as a large percentage of the workforce was hit with COVID. They're all back to work now. So fortunately, we haven't seen high degrees of real severity of illness. And we've learned -- back to learning, we've actually learned to work remotely because a lot of people were still working remotely even ahead of COVID. So long story short, we've already experienced some of the waves on our workforce in '23. You won't hear us talk about it in the quarterly call. So we're feeling that it's going to be more of a, if you will, normal cadence of business in China. And then hopefully, this also leads to improvements in the overall economic growth in the country, which I think is really part of the reasons behind some of the changes. And then we're also hearing some indications that there may be some stimulus coming the way in '23, still early days. So there's -- I'd say right now, there's more net positives than net negatives relative to what's happening in China.

Maybe address that stimulus because we were talking about it earlier about it could actually represent an upside for the back half of the year, particularly in the academic channel within China. Maybe talk about the dynamics of actually the stimulus money translating to spend in China relative than what people like you see in the U.S.?

Yes. No. So sometimes it's a little opaque in terms of what's going on. But once a decision is made, it gets implemented very quickly. So we're hearing indications that there's going to be money going into, particularly life science research, academic research. And we think once those plans get finalized, they get implemented really quickly. On the flip side is the chips act in the U.S. was implemented with a lot of -- was announced with a lot of fanfare. It's taking some time to actually get the point of money being there. Now the good news is we're actually starting to have conversations with customers about what this means for the new facility. So it's starting to happen in the U.S., but I'd say, we think from announcement to implementation in China, we can expect that to happen more quickly. So perhaps there's a scenario that says, hey, after they come back from the New Year, get some more clarity and maybe as even as early as the second half of '23. We haven't assumed any of that...

Yes, this is not in your guide.

No. No.

Got it. Moving to the newly [indiscernible] CAM segment, it's obviously had a great couple of years, and you've talked a little bit about some of these secular drivers, semis, lithium battery material sciences, kind of how are you managing these end markets in terms of capacity, spend and focus? And do you feel that the overall CAM segment is significantly less cyclical than it has been in the past? And I do want to follow up this question with sort of overall commentary on resilience of Agilent and how the perception of Agilent is necessarily lined up with the reality of Agilent today when it comes to the resilience. And I think the CAM segment is actually a key part of understanding that.

I'm not looking at your question, but I'm so glad you asked that question because that will be part of our -- continue to be part of our story board, which is a much more resilient company. And the CAM segment is one -- and we purposely changed the name because I've got a support contracts business, which is roughly 10% of all of Agilent. I've got an energy business which is less than 2% and that's what everybody always wants to talk about. Why are we talking about such a small piece of our business? By the way, we talked about this Chemical and Advanced Materials segment just to kind of frame it for the audience, about 35% of that is, what we call, Advanced Materials, about 55% is Chemicals and about 10% is energy related.

It's 20% of the overall business?

And 20% of the CAM -- 20% of the total company. And then this Advanced Materials, we think there really is secular drivers behind it. So what are we talking about? What we're talking about is the revolution that's occurring in the automobile industry where we're moving to electric vehicles, which requires batteries and there's a lot of investments happening in terms of not only in production of batteries, but making them better. And a lot of that is centered in places like China. So -- and that's also a concern from many people's perspective, nobody wants to have a concentration of key supply chain components anywhere in the world. So we're seeing both investments in China as well as in the U.S. and in particular, in this area. We talked a bit about this already. The onshoring that's going relative to -- initially, it was about key ingredients for the pharmaceutical value chain, but now it's really focused on semiconductor chips. So we think there's new, if you will, secular drivers in the CAM space, which makes this market less cyclical. There's still a level of cyclicality there, but not like it was historic. And I think we're going to -- Bob and I, we are going to put in together some material to kind of show this to everybody. But ...

Yes. I think maybe just to put a couple of numbers to that. So the area that is probably the most cyclical is that energy set, 10%. Five years ago, that was about 30% of the overall market. So you can see in -- over this last period of 5 years, a dramatic shift. And then you couple that with more and more services being built into kind of the CAM market as well as part of ACG's expansion. And so you get this more resilient business. And I think these investments in semiconductors, reshoring and then the lithium-ion batteries, that -- those are things that I think are strategic countries and industries that are not going to change in the near term. I think that -- we see those as secular growth drivers that are going to be able to power through maybe some short-term kind of changes in the macro.

Amd I think this is an unappreciated part of Agilent's business as well, which is having the strength in the applied markets is a net positive, right? Because I'm investing in core technology, say, for the pharmaceutical industry, but I can use those technologies in the same end markets as well. And we have a legacy of leadership in the space. Customers know us well. We're well established. So it's a nice leverage play for us as well. And then while it's not in the CAM space, we're also -- as we were talking a bit today, the whole PFAS testing is a new -- but PFAS testing is also a new secular driver for the business we haven't seen for some time.

Yes. I mean, PFAS was funny when we initiated on the sector in 2020, we wrote about PFAS. And no one wanted to talk about it. And so it was just crickets. But I think it's -- you guys were probably the first one to really start talking about PFAS. And I think the technology has now come to the point where it's implementable and the problem, given some of the new regulations that are coming in and will be coming, I think the problem is being recognized. So maybe help us frame the size of the market today, the growth rate, what your share of that market is today? And how do you see this playing out over the next couple of years in terms of future regulatory EPA getting involved? How do you think about it?

Yes, I think the audience is probably already quite familiar with the word PFAS, but again, we're talking about the forever chemicals, and you may have seen some recent announcements of large companies getting out of the space because it's very clear that there are some issues relative to health consequences. There's thousands of these. We're seeing indications that there's going to be certain -- sort of chemicals will be regulated. And we think this is early days. I think perhaps the reason why we're talking about it is we're the leader in the space. So we sized the market at roughly $200 million, we're probably half of that right now. We think that this has got multiple years of double-digit growth ahead of us because it's going to be a regulatory-driven marketplace. The regs themselves are still evolving. A lot of it is now state by state here in the U.S. But you could see eventually perhaps something happening at the U.S. national level, the EPA, I think you'll see regs happen in EU as well as China. So -- and I think there's going to be continued focus on the research because it's still not clear exactly what -- it's everywhere. And how concerned should we be about all of them or is this a subset of them. So I think there's going to be money in the research.

So we've really started seeing kind of kickstart with the Infrastructure Act here in the U.S. And speaking of time, it took to give money from an act actually down to companies and states and so forth. And I think that that's where we're starting to see that state-by-state regulation. But I think now what you're seeing is potential for EPA to have standards across water testing in some areas. And I think that, that is -- would be a real growth driver in terms of just the volume of screening that would be required. And as you said, the technology continues to advance and the science continues to advance in terms of understanding what these potentially could mean.

And we think this is an expansionary play because to do this properly, you need to have the latest technologies. And we also know that our customers in environment labs, they don't have unused equipment to begin with. So it's not a matter of just running another application on the existing equipment. So we see this as incremental growth.

And for [indiscernible] this is a mass spec plus services around mass spec type?

Yes. And our claim to fame here is not only to have the great instrumentations required, but the integrated workflow, including the sample prep to be able to, if you will, soup to nuts, be able to work with a customer and how to do the application.

Okay. And [indiscernible] we're going to touch on capital deployment. You've already talked a little bit about it. But I think what would be interesting to folks is sort of the sense you're getting from sellers has that -- has sort of the bid-ask spread narrowed and how are you thinking about private versus public, bolt-on versus larger, just your view...

Yes. So I think you're talking about the M&A element of our capital deployment. We're also, as you know, are going to be investing on the CapEx side, as we talked earlier. But as Bob mentioned, I think, earlier today, it says we're now in the same room. We weren't even in the same building before in terms of bid-ask spread. I'd also say that we've historically focused on the private sector, but there now are some interesting things that have us looking in the public space as well. There are some companies out there that have been kind of beaten down, but maybe unjustified so. I mean, they're still kind of -- we've got to be really careful because some companies we don't see viability of their businesses, but okay, that might be interesting. So we're more open to doing public deals, we would continue to do it on a friendly basis though. So we see the valuation as a net positive to this space. We also see HSR as real. So if you're still -- if you're not -- if there isn't anything overlapping, it's an easier path for you to win the deal in terms of approval standpoint. But I think you also do quality deals because money is no longer for you.

Yes. Got it. Well, with that, we will wrap it up. Mike, Bob, thank you very much, and go Eagles.

Thank you Matt. Thank you.