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

Great. Here to kick off the Agilent session. I'm Dan Brennan, I cover tools diagnostics here. Really pleased to be hosting Bob McMahon, Chief Financial Officer of Agilent here at the 44th Annual TD Cowen Healthcare Conference. So first off Bob and Parmeet, welcome.

Thanks, Dan. Really appreciate the opportunity to talk to you and the investors. And also I appreciate having a reasonable weather first week of March here in Boston. I know how it always comes -- so for us, California folks. I appreciate you taking it easy on us.

For sure, for sure. Maybe just kicking off with the news about Mike. So you just announced here, Mike McMullen retiring after a long tenure at Agilent, effective May 1, he'll be a consultant, which is great, till the fall, but you have Padraig McDonnell, who's Head of our ACG Group taking over. Listen, there's always opportunities and risks. I mean you have someone like Mike who's been running the role for close to 10 years. I'm sure it carry some uncertainty for people, but Padraig can instill some new thinking as well. So maybe just kicking it off, Bob, from a high level maybe speak to Mike's leadership style and strategic focus and maybe how you might compare and contrast that to Padraig?

Yes, that's a great question. And obviously, a lot of news there. And we certainly are going to miss Mike. He's certainly been a stalwart here at Agilent, been here with us for 40 years and CEO almost 9 -- 10 years, hired me. And one of the things, if you've ever talked to Mike, he bleeds Agilent blue and is a real advocate for the culture, the people and the culture and the tremendous execution that we've been having -- able to have. And I would say that as part of the process, there was a very thorough process that is both internal and external candidates. And Padraig came out at the end, not surprising for us internally to see what he's been able to do. And I think this cultural aspect that really helps with the transition. So he has been with Agilent for 26 years. And so he knows how to get things done in the company, knows the value of the secret sauce here at Agilent. And I think one of the things that we've really talked about over the last several years is getting even more customer-centric. So he's part of the One Agilent Commercial organization. Actually, as you said, ran ACG -- he may not be known as well as maybe some others to the investment community, but all ACG does is continue to deliver. It went from like 25% operating profit to 30% operating profit under his 10 execution focus. But I would say even double down on what he would call customer centricity and growth mindset. And so I think that area around -- he's famous for calling asymmetrical bets. So really focusing on areas. I think biopharma will be a continued area of focus and probably see even more focus from Agilent in the future. So -- as much as we're sad to see Mike go, he leaves a great legacy demand developing people inclusive of Padraig. And we're really excited about Padraig to be the new CEO come May 1, and you'll get a chance to hear more from Padraig over the upcoming days and weeks ahead. So...

Terrific. Well, thanks for that. So 23 certainly had its challenges. You finished the fiscal year, I believe, like a little over, call it, 1.4% core growth. Maybe just reflect a little bit upon like how '23 played out versus expectations? And as you look forward, what are the key drivers of opportunities that, I guess, give you guys more excitement for '24?

Yes. I would say I'm glad '23 is in our rearview mirror. But the first half played out really well for us. And then what we saw was a number of kind of onetime impacts, starting with about this time last year, the implosion of Silicon Valley Bank, the drying up of the biotech fund. Here, we are fast forward. Now we're actually starting to see biotech funding come back, which I think is a good thing. But through that all, I mean, I think the team maintained focus, was able to really continue to drive areas of focus that may not be an -- we're outside of the traditional biotech things like PFAS testing and some of the applied markets really came through and shine through and are continuing to do that today. And I think that's one of the benefits that Agilent has is this broad portfolio of being able to apply our technologies to 6 end markets. And as I think about '24, I'd think about it in 2 halves. So the first half of '24 is probably going to look very similar to the second half of '23 in terms of year-over-year performance. And then our expectation is that things are going to get better, somewhat a function of comparisons but then also a recovery, particularly in the pharma area in the second half of the year. And so far, we just reported last month -- or excuse me, last week around our Q1 results. We have a little different calendar. And it actually performed better than what we expected. The standouts were certainly places like China, but also the applied markets and positively enough pharma played out the way we expected it to.

So when you think about that, that kind of have skew our numbers -- kind of our full year numbers match yours, and we've got first half, I don't know, we're down 8% in Q2 and then we're up, call it, 7% on average in the back half, but exiting at 10%. So just wondering, like when you think about the -- like that improvement, and you're not alone, and most of the tools companies have a -- maybe it's not the same level, maybe it's steeper, maybe it's not. But how do you think about it in terms of like some competitors look at like 4-year stack trends, right? And you guys have a decent instrument business. So maybe that does play into it, other folks -- maybe like yourself, you're also talking about an organic improvement. So I guess how do investors get comfortable with that trajectory in the back half? And can you just provide more color on that?

Yes, I look at it in a couple of different ways. So we do look at it as -- if you look at a 2-year stack, it's a much more reasonable first half, second half. So that takes into effect the comparisons or the comps. I also think if you look at our instrument side of the business, 2 things. One is we talk about pharma that's probably the biggest area that we are expecting kind of improve versus last year. And when we talk to our pharma customers today, outside of some outliers, budgets are still increasing year-on-year. They're increasing low single digits, low to mid-single digits in both our research as well as capital. That benefits our business over time. And then you see what's happening here in the biotech space that, that will play into that thesis of the second half recovery. So we do look at that sequential and seasonality piece. I think if you look at instruments as well, we look at 2 things. We look at the last 4-year kind of stacked growth rates or compounded annual growth rates for our LSAG business, which is our instrument business. It's been in the mid-single digits, '20 through '23, which says, hey, we're kind of at where we have up and down on the line, but still on that trend line. Q1 was a little lower than that, I would say, hey, maybe we're towards the end, and then we're not calling an inflection yet. But it's still builds on that thesis that we're talking about. So those are the things that we're looking at. The funnel continues to be there. China is stable, which is a positive. And so we'll see how things play out here in the second quarter, but we're cautiously optimistic about how things are playing out.

And then maybe before we jump into some of your end markets, everyone likes LRPs and different tools companies offer them. And I think the last time you guys offered them, correct me if I'm wrong, it was like a 7% -- I think it was 5% to 7% organic growth. And 50 to 100 basis points of margin expansion. That was a few years ago. Just what's the right way to think about your normalized that LRP organic margin is? Is that -- I'm assuming it's consistent, but have things changed at all over the last couple of years?

Yes. Bottom line, we're still -- we still believe in those numbers, 5% to 7% on the top line and 50 to 100 basis points of improvement in margin. I think what we've demonstrated, actually, in a very challenging year last year was actually we were able to continue to improve our margins despite a lower-than-expected top line growth. And -- so when the growth does return, we're expecting to see that continue. So we're not out of gas, so to speak, in terms of being able to grow margins. So I'd say that's in line. I would also say, as we think about where our business has evolved over the last couple of years, we have had more exposure to biotech, we still think long term, that's the fastest-growing end market -- submarket of pharma. And I think the science is proving that. And so we're very bullish about that opportunity. And then I think increasingly, what we're seeing is more recurring revenue. So if we look at Q1 as an example, our ACG business, which is our services business grew 5% despite the headwinds of the instrument business. If you take that piece out of the installation side of our ACG business, our contract business grew double digits, and our on-demand or break/fix grew mid-single. So that speaks to activity in the lab. [indiscernible] about our strategy of actually getting more on contract. And as we get more of our installed base on contract, each one points to $30 million of annual incremental revenue that actually increases our weighted average because we think that ACG over time is a high single-digit grower. And -- so we still believe in those numbers. And actually, our business has evolved actually growing into that higher range of that long-range plan.

Okay. Maybe jump over to China for a moment, and I'll come back to some of the segments. The business, I think, was down, correct if I'm wrong, 9% in the fiscal first quarter. You expressed confidence in seeing signs of improvement. I think biotech was still weak. But you talked about a lot of other pockets. Maybe just unpack a little like what was it that was better? And kind of do you expect that business to continue to improve implicit in your guidance?

Yes, it's a great question, and we were very pleased with our China team being able to really deliver in a challenging market condition. For those who listen to our guidance at the beginning of our fiscal year for Q1, we're expecting actually China to be down about 20% -- or mid-20s, I would say. And so coming in at a minus 9 was much better. Now we talked about $15 million of pull forward because of the timing of Lunar New Year, which was primarily in our instrument business. But even if you take that out, it was still significantly better. And where the areas of improvement were we're really the applied markets. And so we saw actually our chemical and advanced materials market, which is our second largest market globally, actually grew in China. It was nice growth sequentially, but also grew year-over-year. as I think this speaks to some of the secular end growth drivers, that's places like semicon and lithium-ion batteries. And as we think about -- and then our diagnostics and clinical and academia and government also outperformed. Pharma was about where we expected it to be, which was down about 22%. So that gives us confidence that, hey, we've had probably 3 quarters in a row being able to call the number. I know that there were a lot of people thinking that China was going to disappear off the face of the map for [ duals ] companies. And I think what we've seen is a stabilization. We're also seeing that in the second quarter as well, really driven by some of those areas. And then in the second half, we'll start lapping some of those comparisons. And we're still expecting China to be down about mid-single digits for this year, but exiting at a rate to go -- to return to growth in '25. And I think it's behind our instrumentation platforms that go across multiple end markets. We're cautiously optimistic about China. Again, we're still expecting to decline this year, mid-single digits, but we're certainly starting off better than what we had planned.

Right? And then we hosted one of your competitors up here today on pharma and they -- I believe you talked about biotech in China was down 50% in the first quarter, correct me if I'm wrong. So are you seeing, just given where the numbers are, are you beginning to see a bottoming out in the pharma, just like how do you like...

Yes. We have and it's -- we have seen a bottoming out, and I think that speaks to down 20%. And so maybe to frame in for biopharma in China, we're more skewed actually to a small molecule than we are at biopharma. It's about 80-20 small molecules to large molecule. Our small molecule business in China actually performed better than the rest of the world, still down, but it speaks to kind of some of the resilience in that market. And if you think about the broad nature, then we've also got the chemical and advanced materials business. And then our smallest business is the diagnostics and clinical there, but it also performed, relatively speaking, better. And so I think our breadth of portfolio, actually, helps us manage, specifically in pharma, I would say the U.S. biopharma business is probably leading -- U.S. and Europe is probably leading the pack in terms of potential recovery. But I would say the small molecule continues to be relatively resilient across all geographies. And we're expecting that typically goes through cycles. We've been very public about the replacement cycles in small molecule. And I would say we're probably at the bottom of the low end of the replacement cycle. Not ready to call that we're moving up. We are expecting some of that in the second half, a slight move up, and we still think that, that's a mid-single-digit grow over the long term.

Okay. And then in terms of the whole Biosecure Act in the U.S., just how do you think about relations there from a business standpoint. The first wave the government is focused on [indiscernible] and BGI and preventing the U.S. kind of entities that are taking government funds, but our DC people think this could get a lot -- this could certainly get worse. And you could see maybe some trade barriers put in place, restrict some exporting of technologies maybe that you make or peers make to China. I don't know, just like how do you think about China over the next 3, 5 years, should we be expecting a lot of volatility? Do you think this biosecure thing can really have some legs?

Yes. I think you are seeing rising geopolitical tension. So it's kind of back and forth, quite honestly, more generated by the U.S. than China. I actually think that, that in the short term is actually helping us on the applied markets, the semiconductor space as some of these activities are being restricted. I think specifically to the Biosecure Act, we haven't seen that impact our business that much. It's probably more on the next-generation sequencing side. It's something that we're watching. We've got -- our trade team works very closely to ensure that we understand what the requirements are there. And so far, we haven't seen an impact. You talked about 3 to 5 years. We do think that China will get back to growth coming into '25. Our view is that it's probably a mid-single-digit growth company, our market as opposed to kind of a high single-digit, double-digit growth that it had been before. Still a very important -- second largest market for tools in the market. And when you think about the strategic priorities that the Chinese government has laid out in their 5-year plan, life science tools, are essential for them to achieving those goals. And quite honestly, the local competition, while getting better is not where they need to be, particularly at the high end. And so I think there's still an opportunity for multinational companies like Agilent to play. I think what we're doing in China is continuing to invest in China for China. We talked about opening up our new facility there where we can actually provide where needed. It's not a binary thing. It's about 100%, but where it's required -- country of origin for China. I think we're ahead of our competition in that space. And when we think about our scale of our service organization, which is really important and that creates some stickiness. Local competition can't match that. We've got 2,000-plus employees that are servicing customers each and every day that are local Chinese.

Okay. Maybe just kind of switching gears for 1 sec on a big picture question, kind of getting back to the earlier discussion on comps. So if we look ahead to '25, which obviously you're not going to guide for '25. Most of our models for tools, we have exit rates going up in the back half, and we've got '25 numbers, certainly above the LRP, whether it be -- we'd probably have 8% or 9% growth view, I would assume, and most of the companies we have it. Like is it -- I'm not saying that will transpire, but is it unrealistic if you exit '24 at the rate that's implied in your guidance, that '25 can be just normally given comps and above-average growth? Or how do we think about it?

Yes. I think as you said, I'm not ready to kind of sign up for '25 above the long-range plan yet. But certainly, if the recovery continues into it, you have the benefit of the easier compares in the first half of the year in '25 as well. And I think fundamentally, we believe in these markets. And so there's a possibility there, but stay tuned.

Yes. So maybe zeroing back then -- maybe just one more question on kind of China. So you were thinking down low 20s, it came in down 9%. You said here the business, it got better. Was it just a standpoint, you really just baked in a pretty conservative number and they got a little better? Or did you actually see something change with activity, maybe that PMI is still like they're under pressure there. Maybe there's a little more dollars, I don't know just...

Yes, it's a good question. We've been pretty transparent about how we were thinking about the cadence for China. When we were sitting here in July and everyone was saying, "Hey, the world was going to end in China." We said, "Hey, we believe it's been -- it's going to stabilize here at roughly $315 million a quarter. There's some seasonality here and there." And then we've done that in Q3. Q4 was $317 million and then we just did $333 million in our Q1. Take out the $15 million, you get back to roughly that same number. So it's been pretty -- so we guided a little lower than that, but it's been pretty consistent. And then I think what also helps us have some confidence is we talked about our book-to-bill in China was over 1. So it's been over 1 for several quarters now, which speaks to some predictability and stability in the business. Again, we're not ready to call an inflection when you look at it sequentially. The performance year-over-year will get better just because of the comps. But I do think you're seeing a stability on a monthly basis in China, which gives us confidence that maybe we've hit this bottom and then getting ready to reflect or inflect some time in the future.

And maybe last one here, sorry. Have you seen any contribution increased, step-up from the government? Like have they done anything to support the pharma, the academic labs, any of the broader industrial, like anything on that front?

Yes. I wouldn't say anything material. I think our team has done a good job. I do think that there has continued to be investments in places like semiconductor, where the government has probably put in more money than they expected to there. That certainly -- I wouldn't say that's stimulus necessarily versus kind of investment in capacity. I do expect some continued investment. One of the things that we're seeing is, while you're talking about WuXi and so forth, they're investing outside of China, but there's also investment going into China by multinationals and sometimes to capture that in China for China opportunity as well as the local companies. And so I would expect that to continue. And I think given our presence in China and the fact that we have the ability to not only provide a product that can be sourced from outside China but also locally sourced, we have the broadest portfolio, and I think that serves us well.

On your LC business, you talked about being at the bottom of the replacement cycle. Is that globally or is that just in China?

That's globally.

That's globally. Is it -- does that all [indiscernible] in China [indiscernible]?

It does. Yes. I mean we talked about China actually on a year-over-year basis, actually performed better than the rest of the world that I would say they're over-indexed to small molecule, and I don't want to call it being kind of a canary in the coal mine, so to speak. But certainly, we're very pleased with the performance that we had in small molecule. And I do think that -- there's probably still -- in China, biotech is probably still going to be challenged. I think you'll see biotech or large pharma or large molecule recover faster in the U.S. and Europe than in China. Just given some of the investments that they've been making over there and catching up with capacity, whereas I think it's more broad based on the small molecule side. We saw customers almost uniformly kind of hold back or defer investment after a period of accelerated investment in '21 and '22. But if we look at the age of our installed base, it's kind of in the median of what it's been historically. So it's not the oldest it's ever been, but it's also not the youngest. And so you actually -- every quarter goes by, it gets -- it starts ticking up, and you can only hold on for so long before you need to replace that instruments. And I think there's a push for productivity in pharma that continues, particularly in some of these markets. I think that actually speaks well to potentially, actually, if you can show value, whether that be through our services organization or actually through a new instrumentation what we've seen is customers will pay for that back.

So maybe just on the global biopharma, you kind of lowered your growth rate a little bit for the year. I think you were thinking a low single, now it's flat. And I want to hit on NASD, which you definitely called out. Was there anything else? Was that the driver of that delta or any other parts of the business that were a little bit weaker that you kind of took down numbers on?

Well, that was really it is the NASD business, and we see this as a transitory thing. But I would look across the business in our biopharma and said, hey, first quarter came in the way we expected.

So then maybe just on NASD, you talked about, was it one -- you talked about some clinical trial pushouts. Was it 1 customer? Was it multiple customers? I know you're very positive on the long term. But just maybe speak to a little bit of actually what happened?

Yes, it's not 1 customer. What we're seeing is a number of customers kind of evaluating their clinical trial pipeline and when they are -- what indication are they planning to go to market with first. And some of our customers, the plan was breakthrough designation, get on the market quickly with an orphan indication and then build indications. And what we've seen now is some customers, not all but not one, saying, "Hey, let's take a step back. Maybe we want to go after the larger indication first." That creates a temporary kind of push out and then go after some of the additional indications. And so that's why we're still positive about the long-term aspect here. And if you look at our clinical business in NASD, it's growing very nicely year-over-year. Both the number of programs, number of molecules as well as revenue dollars. And I think that bodes well for future demand. You just get to a point throughout the course of the year where they say, "Hey, I still want it by the end of the year." That's the end of the calendar year, it may push out a month or 2, and that shows up from one quarter to another for us.

Got it. Right. So you took that from mid-single to flat. So I guess the expectation is what you just said, it sounds like it's months, but for -- again, we're not talking about '25, but to say flat in '25, we should probably expect some recovery to...

Yes. It's -- obviously, with clinical trial demand, there's higher risk. There's different risk, I should say. But the more we fill the funnel, the more opportunities there are. And what I would say is when you look at our NASD business, I think there's a potential view that, hey, this is all emerging biotech or early-stage biotech that's filling up the pipeline. I would -- it's actually not that. It's actually large pharma that's going into siRNA. And you can look at many of their R&D days and several of these large companies are looking at siRNA as a new therapeutic mechanism to go after a number of different therapeutic areas. And so that's pretty exciting for us. And we are still -- we view ourselves as the gold standard of GMP-grade siRNA. And the more clinical trials we have, the more opportunity for getting that downstream commercial because you are spec-ed into the clinical trial, you're in the dossier and then when that gets approved, then you typically will get the commercial volume.

Right. You talked about at one point $900 million of revenue potential once Train C and D are open, which I think -- you said revenue was starting '25, like. Was there any timetable attached at what point that could be realized? I mean, we have $350 million in fiscal '24 NASD revenue.

Yes. So Train C and D, which are the 2 trains that are being currently constructed today are coming in on schedule, which was '26 and '27. And so that would be a kind of full running in the '27 time frame, not '25.

Right. Right. But that's the potential or I mean it could actually be $900 million in revenue [indiscernible]

That is kind of how we modeled the revenue for the facility. So certainly, it's potentially -- it requires some of these products to come through. But the way we did this is we looked at our current installed -- our current customer base, the number of programs they have and then made a very modest assumption about new programs and discounted that, looking at the success rates that we've seen to date. And so it could be if more things -- I would say, a balanced forecast, not at an optimistic forecast.

And the $350 million in NASD revenue this year realistic? I mean, are we in the zipcode there?

Yes. zipcode. That's based on what we know today. .

You've been very aggressive with acquisitions. And as you have [indiscernible]

I would say, based on where those acquisitions have happened, there haven't been a whole lot of assets that we say, boy, we wish we had. Now that being said, I do think that M&A is an element of our playbook that last couple of years, we have been -- because of valuation and then last year, given the market challenges, we were probably lower -- slower than we've had historically been. I would expect us to get back to kind of our historical run rate of adding some value accretive or growth accretive assets over time. And I think Mike actually made a comment on the Q1 earnings about the funnel being active. I wouldn't take that as being imminent. I would take that as, hey, we've got a very strong balance sheet, strong cash flow, and we're in a better position than maybe some of our peers, maybe not the giants, but many of our peers.

Yes. No, that was my second last question. But maybe centered on the topic, just in the past, Mike has talked about maybe going up to $2 billion, I believe, right? Like is that still the zipcode of like what's...

Yes. What I would say is we've talked about multiples of the biotech, which was $1 billion. We could do a $4 billion to $6 billion acquisition without impacting our investment grade. We'd have to look at the right asset. I would say our sweet spot is between $1 billion and $2 billion. When you start getting into those larger numbers, it gets harder to compete with some people that may have deeper pockets. That being said, I think we can compete against anyone.

So chemical and advanced materials, not CME, that was a segment that when the economy has gotten weaker in the past, it's been like a -- certainly a risk for you guys, but you've had this benefit of these advanced materials business is doing really well right now PFAS, electric batteries, right? But the business has slowed, right? I mean you're going from 18% growth in fiscal '22. I think you were like 3% growth in '23?

Yes. That's right.

So right now, you're talking about a little better growth in '24. Just kind of walk through a little bit of the composition, how much is the more commodity or the more cyclical part of the business, how is now commodity? I mean you have a leading share in GCs I get it like how is that business doing versus the faster business like the faster...

Yes. It is -- so if we think about our chemical and advanced materials market, there's 3 subsegments of that market. There's a chemicals, which is roughly 55% of that market; there's energy, which is roughly 10%. So those 2 combined is about 2/3 of the market, and then advanced materials is 35% or about 1/3. That chemicals and advanced material has been driving the growth. I would say the difference between the [ 18 and the 3 ] was largely on the chemical side, which was in China last year, which had seen lower growth. I think we're expecting very modest growth there or not much improvement, I should say, year-over-year on that. And the growth is really driven by the advanced materials being a bigger part of the business. Now what I would say is, if the economy improves faster, looking at PMIs and so forth, it does correlate, not perfect, but there is a correlation there that would benefit the chemical side. But even if we looked at Q1 as an example, advanced materials grew -- or performed much better, I would say, than the chemical side. And we are -- I would say, remain cautious about that side until we see actually a turnaround. And -- but we're much more optimistic about the advanced materials given the secular nature of some of the actions that we're seeing not only in our customers, but government is driving in terms of investment in those areas.

So that business, the applied business is growing at what -- so it's 1/3 of the business? And is it growing?

Yes, I would say mid- to high single digits.

Mid- to high single digits. Got it. And just on the more chemical side of the business, like we -- like is it a point we're at kind of a bottom? Or is it -- or things are worsening?

No, I don't think they're worsening per se. I mean it kind of gets into kind of the -- really the GDP and GDP is actually in PMIs. And I think we've been kind of bouncing around at the bottom here and I think what we're assuming is that it's going to stay kind of similar on a sequential basis.

So if you look at, say, the next x number of years, not 10 or 5, let's say, 3 years, like Agilent has been very block and tackle, right? You're just consistent, you perform, like you've got some volatility, but you guys just deliver the next 3 to 5 years, maybe back to the M&A question or just like how do we think about the -- like the business? Is it just stick to the knitting, exactly what you've been doing? Are there areas you want to invest more in? M&A, I think we've already answered, you want to be opportunistic, but it sounds like you want to be a little more aggressive. Just how do we think the portfolio or the business as you look out the next 3 plus years?

Yes, I would say a couple of things. I mean, stay tuned. We obviously have a new CEO that's coming on board. I don't expect him to do any anything dramatically different than what we've been doing because it's been successful. I would say, as you look at it, I would see us continuing to expand into those higher growth areas. We still are a big believer despite kind of the pressure here in biotech that biotech will grow. The notion of continuing to drive that connect rate has a nice flow-through of consumables as well as services. And then you add on these areas of applied markets we're by far and away the leader, I think you'll see us continue to move into higher growth areas. And then I would think about M&A as optionality. And -- so I don't think we are being hurt by not having any -- there's no big gaps in our portfolio, but I think you can think about us as actually moving into adjacencies based on the strength and the scale that we have. And so that's where I think this long-range plan is still intact. And actually, the market and the business actually drive us to that higher weighting because the faster-growing areas are becoming bigger parts of our market. And one thing you can assume is that, that focus on customer and that customer satisfaction, that service orientation won't change and neither will our operational execution.

Great. Well, Bob, with that, I think we're out of time. So thanks for being here. Thanks, everyone, in the audience.

Thank you.