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

All right. Good morning. Thanks, everybody, for joining us and being here. I'm Brandon Couillard from the Life Science Tools and Diagnostics team. Welcome to the Jefferies 2023 New York Global Healthcare conference. Very happy to have Agilent with us at the conference today. Joining us, CEO, as most of you probably know, Mike McMullen; as well as CFO, Bob McMahon. Thanks, everybody, for being here.

I think we agreed to share the mic. Hey, Brandon. So it's a pleasure to be here right on the heels of our recent Q2 earnings announcement. So pleasure to be here as always. Well, I think Bob is happy to be here as well.

Maybe to jump into things on the topic dejour. That we've been having a lot of investor conversations about and we certainly are thinking -- coming out of earnings is, it's just kind of trying to understand what's going on with instrument demand broadly. And now with a little bit of hindsight, how would you sort of characterize, I guess, the last 2 years in terms of whether that was some degree of pull forward and just kind of recap us on what you're seeing in your instrument business coming out of the second quarter?

Yes. As you know, I've been in the industry for a number of years. I think the last few years have really been a different kind of cycles than we've seen historically, obviously, driven by the dynamics from the pandemic. And what -- and we've been on record on this earlier, particularly in certain aspects of some of our larger markets, the pharmaceutical market, the small molecule side of the marketplace. We wouldn't say it was a pull forward, it's been more of a catch-up. So as you know, about 70% of that business -- of our business is in small molecule. A lot of that's just replacement of instrumentation. So customers will, at some point in time need a -- continue to make sure their fleet of instrumentation is up to date. So we were seeing really strong demand, 20-plus growth rates for a number of quarters in liquid chromatography area and probably 12 to 15 months ago, it's lessened, things will start to move towards their long-term growth rates. So don't expect 20% growth rates to continue. So when we set up the guide for this year, in fact, we had anticipated that -- you start to see some level of moderation, particularly in small molecule. But what we actually saw in the second quarter was actually a more significant slowdown than we had anticipated. But some of those trends, I think will eventually -- and we'll probably talk about cycles and other things replacement cycles, but long-term growth prospects of the markets in pharma remain really strong. But as you saw in our recent quarter, that's really where the slowness was centered in terms of the outlook.

If we're just looking at the instrument end, is it primarily biotech mid-pharma? Is it more industrial customers? Is there any trends you need to speak to, in terms of geographic...

Sure. So it's interesting. So I've been in this role, I think, 30-some quarters and we only -- we've had -- every quarter has either been single -- I mean high singles or double-digit growth in pharma except one. And -- but we're starting to see some different dynamics right now. And I think the -- when you look at our outlook for the second half of this year, the slowing that we were projecting relative to -- and by the way, I keep want to remind that we had some previous strong numbers to compare with the prior years. That being the case, to answer your question, which is really centered in the pharma market, primarily in the United States and China, and we can get into the geographic dimensions later on in our conversation. But let's kind of dissect a little bit between mid- and large pharma and biotech -- emerging biotech, because I think there's 2 really different stories here. Mid and large pharma, the funnels are active. The funnels are strong. The orders that we have in backlog remain high quality. There's no cancellations, but there really is a level of conservatism in terms of improving new capital. So we haven't heard that their budgets have been reduced for the year, but they're also not releasing them. So that's why we know at some point in time, we'll start to see an uptick in that end of the market. We're not calling for it right now. As you may know, we're saying we expect the -- this kind of environment to continue at least through our fiscal year, which as you know, ends October 31. Biotech -- emerging biotech is a completely different story. Surprisingly, we -- for the first half of the year -- but, I think we were actually pretty strong in this area. New customers are still finding ways to get access to cash to be able to buy new instrumentation and then also support their ongoing application to work in the lab. But that's now will shut down. I mean there's really no -- they're really trying to conserve cash. So there's not a lot of new deal activity happening right now in emerging biotech. Now [ first it what ] about 3% of revenue...

Yes. I'm going to say maybe to frame the -- our pharma market is the largest -- it's a little over 35% of the total company. Within that market, 90% is mid- to large-size pharma and 10% is kind of that emerging market. So it's about 3% for the total company.

If we look at the instrument business kind of broadly, it's been kind of a new exercise in terms of assessing everyone's kind of instrument business profile. You do a lot of different things such as LC, right, big in mass spec, GC, spectroscopy. Can we break down that 40% of your business that is instrumentation in any kind of granular way? And can you speak to some of the differences in demand trends? Is there any nuances between different classes?

Yes, sure. So maybe kind of start. So our fundamental strategy for a number of years, that really has been to broaden our -- be a broad line supplier into the lab. So we continue to broaden out our technology platforms. We built up a nice spectroscopy business. We continue to expand mass spectrometry and we always had a real strong core in chromatography, and we'll probably talk a little bit later about the cell analysis business as well. And our strategy has always been, and I think this really gets to some of the nuances of your question. Our fundamental strategy says, if we can take core technologies and applicate them into multiple markets, you get a -- it is a great growth model and also a great margin model. And why I'm bringing this up is the -- some of our platforms have different end market characteristics, and we call these the [ bright ] markets , which is a really area of strength for us. And when pharma is slowing, we do think that the growth for pharma will return. The question is when? But these other areas such as environmental testing, food testing, these other areas platforms where they applicate it, are continuing to be quite strong in terms of funding in those end markets. But if you look at the profile of our business, chromatography, mass spec, they are the biggest parts of our portfolio in terms of contribution to revenue. We saw more mass specs than anybody in the world. If you go GC/MS, LC/MS, ICP/MS. This is where we get a lot of leverage in terms of our platform development. So we -- a lot of common components, a lot of common software. And then the primary markets for those products remain the pharmaceutical market, albeit the outlier would be gas chromatography which is sort of the heritage product line of Agilent, that are really strong in the CAM markets. And why is that? And I use the word CAM, this is our chemical and advanced materials market. We actually think that there's some new secular drivers that we've been talking about for a while in the CAM market, particularly as it relates around the advanced materials piece. So there's pockets of -- even though there's some overall the overall investment profile of new capital investment has slowed right now, there are pockets of continued strength. And I think this diversification of Agilent's end markets really is part of our story as well. Anything else to add to that, Bob?

I do want to dig into that part of the [indiscernible] business in a moment just to, I guess, round this off. You were one of the only companies that kind of articulated a view that this might be a -- I think you said 12 to 18 months sort of correction process based on, I think, historical sort of trends. Given we are coming off of very tough comps, will this be a normal correction cycle and how would you describe, I guess, your visibility today compared to your...

Yes, it's a great question. So I remember I got this question, I think, in an earnings call against other people were calling for much shorter cycles. And I think that's also important for us to kind of characterize what are we talking about. So in -- we're talking about a replacement market. So -- and -- and we're primarily talking about replacement market for LCs and GCs, but primarily the chromato gas. There is always a replacement market going on. So customers have fleets of instrumentation in the lab and over time, they want to make sure they keep that -- their fleet up to date. They may choose to slow the replenishment process because of what maybe happened in their particular business or in the marketplace. So what we're really talking about is rates of replacement. And what we saw back in 2018, 2019, they actually had slowed the rate of replacement. And that was probably 12- to 24-month cycle. And then what you saw happening was when you hit -- had COVID going, pharma had more cash available, they did an accelerated catch-up. So -- and what we've been calling for, for some time is, ultimately, the market will move back to what we think is a mid-single-digit kind of growth profile for replacement market for LCs. We have been growing 20% plus for a number of quarters. We actually post a minus 1% Q2, which we don't think also is a long-term growth rate. It's hard to know exactly when these cycles will change because it's -- and if anything over the last several years, I think we've learned that history is not always a good guide when you're dealing with -- hopefully, what will be a once in a lifetime global pandemic. But we do know there will be a turn. And right now, what I can say for sure Brandon, is we're not assuming anything to happen in the next 6 months. But I would be surprised if we don't see something happen over the next 2 years. I mean, so I think I think we still feel that's a reasonable way of looking at it. But once I see it start turning now, we'll be sure to let you know.

Shifting gears back to the CAM business. And this is a segment of Agilent that -- for health care investors is uncomfortable in terms of the inherent sort of cyclicality of some parts of that segment. You've been on a tier for the last 10 or so quarters. I mean, kind of consistent high single double-digit growth. How sustainable is that? And then how would you sort of, I guess, describe the sort of go-forward growth profile of CAM given some of these newer secular markets?

Bob, I think I may actually pass this over to you because I was thinking about when you first joined the company, you did a road tour. And there is this perception of Agilent being highly cyclical, really driven by the chemical energy business and then ultimately have changed the name of that business to CAM to better reflect really the different growth drivers in that segment.

Yes. Yes. And maybe it's helped to kind of frame that. That's our second largest end market, little lower 20% of our total company's revenues. And if you kind of peel the onion back, there's really 3 segments of that -- subsegments of that market, about 55% of that -- 55% of that is kind of chemicals. Then you've got 5% to 10% as kind of energy. And then the remaining, which is a little over 1/3 is Advanced Materials, and that's the area that's really been driving the growth here. And what's in that is these newer technologies, driven by kind of lithium batteries, the electrification of the automobile industry and so forth. And we think that those are secular drivers that are going to continue to grow. And so we've been very pleased with that performance really been driven there. All 3 of those areas have been driving growth, but it's really been that 35% of the business that has been driving this. And within semiconductor, I think people think about that cyclicality. We're actually seeing additional capacity being brought online. We're not seeing any -- and then with the additional funding that the governments are having not only here in the U.S. but in Europe, I think there's a real desire to diversify and build resilience into the supply chain, so it's helping our business there. And then on these newer technologies like lithium ion -- lithium batteries, that's just early days. And so we're thinking that, that those are opportunities will continue to drive growth. I don't know if it's going to be at the same level that it is now. We've actually been ahead of the curve, so to speak, in the first couple of -- first 2 quarters of the year. We're still projecting within the revised guide mid- to high single-digit growth for our CAM business.

For the full year, yes.

For the year. For the year.

Yes.

We're going up some very tough comps in China as the recovery last year. And that's a big part of our business there, but we're expecting that business to continue to grow.

Yes. And if you look at our long-term growth rate, So Bob and I updated the long-term growth rates at our latest -- last that was about 2020 when we did our last Analyst Day. And 5% to 7% was our long-term growth rates. There's no reason why this can't be a mid singles at least growth place. And I think it's also important to kind of, if you will, kind of peel back the onion, so to speak, let's just call CAM roughly 20%, 21% of Agilent's revenues. What are we talking about? We're talking about the cyclicality piece really is tied to the chemicals side, which is about 60% of that and roughly half of that is CapEx. What these -- what our customers always are doing are buying consumables and services. And that's why our services business is so important the vitality of the company. So you're really talking about a 7% to 8% kind of total revenues. I think because the reason I'm really passionate about this is, in 2015, we really went about trying to change the profile of the end markets we serve and also mix of CapEx versus recurring revenue. We're not claiming we're completely immune to economic cycles, but it's a lot different story than it was a number of years ago. And I think -- in fact, I would say the health care investors should be attracted to the idea of being able to participate in some of these secular growth drivers like the revolution that's happening right now in the automobile industry, for example.

And we are, by far and away, the undisputed leader in that market.

When it comes to EV batteries and the...

And CAM is...

I mean, we're like 2x to #2. So this is our market. So -- and it's a market that we know quite well. But then again, as I mentioned earlier, I serve this with the same technology platforms that have been -- I used to develop to go after the pharma and biopharma market as well.

There's not a day that goes by that I don't see a PFAS headline in the news. It just continues to sort of [ mushroom ]. And you seem particularly well suited to lead that market as well. It's booked in your environmental segment actually. Can you just talk about what you view as your market share there? You had a tailored PFAS system launched at ASMS this week. How big is this opportunity?

I'm glad you caught that.

To speak to, I guess, that opportunity and how big -- I guess it is today and could be overtime?

Yes, sure. Happy to do so, Brandon. So if you've -- you probably already quite familiar with Agilent's history in the environmental market, but this is a market where we build our mass spec business in the '70s and '80s and in the '90s. So our customers know us well. We're viewed as the leader in the space. It was a market that initially was served with the GC/MS, now LC/MS has really become an even more important tool in there. And this is where a lot of the PFAS work is done. So long story short, again, we have a heritage of strong customer relationships in the environmental market, not only in the U.S. but globally. We know the space, we know the application. Customers trust us. We have the ability to support their application. We have the ability to actually train them and how to do these new applications. So long story short, we believe that we're the leader in this space with at least half of the market. We conservatively estimate the market to be about $200 million right now. We think it's probably growing 15-ish-or-so percent per year. It's primarily right now being driven by the U.S. As you know, the -- there's been some new EPA regs, coming now, I think it's 1633 is a reg that our application services. But -- so we think that this is going to be a great growth opportunity for us to have sustainable growth because this is one of the situations where a lot of the funding for this comes from the government. And there's a lot of interest around the world in terms of improving the quality of life. So we think these kind of investments will give us some level of offset to any kind of economic cyclicality that could be out there. Again, primarily a U.S. market, but we think there's no reason why you won't start to see it go into Europe, China, Japan, where they're also going to be working on their own set of tailored recommendations. And this is, I think, the first reg only covers, what, 6 of the chemicals out there. So -- and there's thousands of these. And by the way, what we're talking about right here, Brandon is the regulation side where you need to do wastewater and soil analysis against -- for looking for certain contaminants. There's also money going into this space relative to research because really trying to understand the human health consequences of these forever chemicals that are out there everywhere. And other is, also you'll start to see more and more testing done for litigation reasons as well.

Yes. Just I was just going to say, I mean, it's really emerging, and that's one of the things, there was an article a couple of weeks ago about class action lawsuits down in Florida about PFAS testing and being in water. And we're also starting to see early stages of potentially it being tested for food as well, in terms of the packaging to ensure the various regulations. So that's potentially an emerging area but it's primarily in that environmental area and so forth. So it's something that bears watching and it's certainly is something that we're excited about being able to participate and helping identify those chemicals.

I'm really glad you brought this up because biopharma is our largest market. What Bob and I have been trying to do over the last several years with our team has been to build multiple growth drivers for the company. So this environmental segment is going to be a nice, nice adder to our growth down the road.

I think one other sort of unique growth stool for Agilent is your NASD business. You're opening the new Train B line, I think right now...

We're getting close this quarter.

This quarter.

This quarter, yes, we're getting close.

How should we think about this market, the growth opportunity? as many of these programs start to go commercial. There's one from Iveric, I know you're expecting too. Is there any way investors can sort of conceptualize what that opportunity can be as we go from 1 or 2 drugs on the market to several more?

Probably -- so first of all, we're very excited about this business. It's a business that was when I first came in a role was $60 million-ish. And then we decided to -- we saw the promise of the therapeutic development, and we made some initial investments was led to the construction of our current Frederick site. And as you know, we're in the midst of expanding that even further. That business is now north of $300 million for us for the year. So it's -- and the best way I think to go is go back and look at some of our external presentations and also some announcements we made around the additional capital we're going to invest in terms of further going beyond this current expansion. And Bob, I think you were calling for a $1 billion business for us in a multi-billion dollar therapeutic market. Now keep in mind, we are providing the API for the therapeutics. So we're not cleaning the -- we're going to own all the therapeutic market, we're a key supplier. And this is really where you start to -- the reason why we have stepped up our level of investment is there's increasing signals that many of these therapeutics will get through their clinical trial programs and get on to market. So when we built our first train -- our first production line in Frederick, the science still wasn't as proven, and we've built that based on clinical trial demand only. And then we're about halfway through finishing that. We started realizing, hey, we're getting indications from our clients and from knowledge experts in the industry that these therapeutics aren't really going to start to take off.

And maybe just to add a couple of other pieces, today we're about 50-50 clinical volume versus production volume. It obviously depends on the indication that the drug is going after. But production volumes could be anywhere from 5 to 10x. And then it's obviously predicated on the success of the molecule. But the thing that's exciting for us is many and more of these molecules are actually being targeted at a larger patient population. And so you're actually seeing -- that would be 5 to 10x kind of depending on kind of the success of those molecules, there would be a nice revenue annuity stream associated with that. And that's why we made the incremental investment earlier this year to build out Train C and D. And C and D also are expanding our technology footprint. So not just siRNA molecules but we're also doing GMP-grade CRISPR. And we already have a business in NASD there that's in the tens of millions of dollars, but we see this as an opportunity to really expand that going forward. So we're not only increasing our capacity with the existing technology, we're also broadening our kind of therapeutic footprint or modality.

Bob, in a minute we have left, I would just want to touch on the guide if we take your 3Q guide and back into the fourth quarter, it implies kind of like a $190 million revenue step-up in the fourth quarter. It's well above kind of historical seasonality. Can you just unpack what supports that step-up into the fourth quarter?

Yes. A couple of quick things. It is a little higher than what we've seen historically. But I think one of the things that we're thinking about is when we look to last year, we're assuming this year a faster conversion cycle. Last year, we actually -- and in fact, we mentioned this in the call in Q4 of last year, we actually got orders earlier in the quarter for end of year delivery, not end of fiscal year, but end of calendar year because of extended delivery times. And now what we're back to kind of normal pre-COVID delivery times for our products. And so what we're expecting to see is the order performance will actually drive faster order conversion in Q4, which will help year-on-year improve the sequential increase from Q3 to Q4.

Okay. That goes fast. Unfortunately, we're out of time so we'll have to leave it there. Thanks, Bob. Thanks for being here.

It's our pleasure.

Appreciate the inviting us.

Great to see you.