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

All right. We're good to go? Good morning, everyone. I'm Tycho Peterson from the life science team here at Jefferies, pleased to introduce Bob McMahon from Agilent.

Great. Thanks, Tycho. It's great to be here, and good to see you in the saddle.

Thank you. Two old men wearing glasses, we're getting old.

Let's talk about 2Q. Why don't we start there? And just as you're kind of thinking about things going forward, obviously, a lot of headwinds, NASD, pharma, instruments, China. Maybe just kind of talk through each of those dynamics and how we should be kind of thinking about next couple of quarters.

Yes, yes. So our Q2, we actually met expectations. Revenue was down about 7%, right in the midpoint of our guidance and actually had leverage on the bottom line decline about 4%, exceeding our expectations. And as you were saying, we did have some headwinds. But if I look across the group, we delivered what we expected to deliver in Q2. And there were actually some positives coming out of there. And I'm sure we'll talk about some of the challenges that we see in the back half of the year. But one of the things that was good is for the third quarter in a row, we did have a positive book-to-bill. And then first quarter in 7 quarters, our orders actually grew. And now they didn't grow the extent that we expected. And that was the reason for the takedown for the second half of the year. But there were some things that did say, hey, there is a recovery happening in the market, maybe just not as fast as what we expected.

I think the number one question we got as we were talking to folks after yesterday and the day before is guidance, kitchen sink, Mike is on his way out, right? So with the CEO transition, I guess, how did that factor into the guidance framework and...

Yes. What I would say is we were -- we called the guidance down based on what we saw today. And we certainly are not assuming -- there are some opportunities that could play out better. And I'm sure we'll talk about this China stimulus. We haven't built anything into our guidance there. Also, we've talked about pharma, which is the biggest cut. We have not seen budgets being cut, just a slower release than what we expected. And that would -- that could suggest a back half of the year higher-than-normal budget flush. We haven't built that into our numbers. And what I would say is we certainly appreciate the magnitude of the cut. No one is more disappointed than we are, we also don't want to have a series of cuts. I'll leave it that way.

Yes. You don't quantify order growth. It's been a while since you did that. But any qualitative comments you can give us on how we should think about...

Yes. I would say all three of the groups -- or I would say orders grew very strong if you include NASD. If you take NASD out, we actually grew low single digits. We were expecting a little more than that. All three of our groups had positive book-to-bills. And when you look at our LSAG business, which is probably the one that's most relevant in terms of orders, all regions for our instrumentation grew with the exception of China, which was again a positive. And in the -- while China was down, it was actually down less than revenue.

And I guess, as we kind of think about maybe just a little bit longer term, you guys have benefited from double-digit growth in China in the past couple of years. You had a 100 basis point tailwind from NASD. I mean, has the kind of long-term view of your growth profile changed at all?

Yes. It's a really great question. And the short answer is no. We do believe that the algorithm of 5% to 7%, a few points ahead of market growth is still appropriate for Agilent. And I think right now, there's a lot of focus on those two areas. We're still very optimistic about the future for NASD. When you think about NASD as an example, right, while it's down mid-teens this year, the number of clinical programs that we have is the highest it's ever been. And actually, our clinical volume, and when you look at it, is going to be growing in excess of 50% year-on-year. So that actually speaks to the future opportunity there. And China certainly is a headwind for the market. But we're looking at opportunities to get that back to kind of mid-single-digit growth versus double-digit, what you said. And then what we've seen looking forward, which we haven't had near as much in the past, is two things. One is our services business is a much bigger contributor to growth. And then you've got some applied drivers, and I'm sure we'll talk about, on things like PFAS, semicon, batteries. Those things are just getting started really in the opportunities there. And that's where we have an undisputed leadership.

And just to clarify, 5% to 7% for you guys, you're still assuming 3% to 5% market growth?

Yes, that's right.

Cool. So China, if you kind of normalize for some one-timers, $15 million or so on one-timers, the math is about $20 million in terms of how it got worse. Can you maybe just touch on what you saw sequentially there, where the pressure points were? And then obviously, everyone is thinking about stimulus. What are some signs we can look for that, that's going to start to flow through?

Yes. It's a great question. And I think that is an important way -- important to look at it. Because when you look at just the absolute numbers, it would say, "Hey, we were down sequentially $50 million." But we talked about the $50 million or $15 million pull-forward. So $20 million is the right way to look at it. I would say it did expand a little beyond pharma in terms of some of the softness, primarily in the applied market, so food and environmental. Chemical and advanced materials was actually strong. It's actually -- it grew year-on-year in China despite very strong comparison. So you can still see activity there. And so that $20 million was really on the -- there was a little in pharma, but the rest was in primarily food and environmental and academia, which was going up against tough comps. If we look forward on the stimulus, what we actually saw in Q2 was increased bid activity. But we actually feel like there was a bit of a freeze in the market. It's almost like 2019 with the 4+7, for those who may have remembered that, where there was some concern out there. Markets stopped for a couple of quarters and then reaccelerated. This, we saw that here, I think, in the order perspective, trying to understand -- our customers trying to understand what the stimulus is. What we know about the stimulus right now is it's much larger than the one that happened last year, which was primarily focused on academia and government. This actually has both a pharma component but also an industrial component. And like I said, we've seen bid activity increase, but we haven't seen the funds release. And so what we've done is not assumed anything in the back half of the year for an incremental benefit of stimulus. But we know it's going to happen. It may happen in '25 or the tail end of '24. But we're being, I would say, prudent from the standpoint of not trying to time it because we haven't seen the details yet.

And maybe just touch on where you might see it in the portfolio? You mentioned obviously pharma and industrial. So maybe just talk a little bit -- it's a broader program this time, so some of the...

Yes. It is a much broader program than the last one, which was focused on high-end research and primarily in the academia area. And so what this -- we would expect this to go across multiple end markets. So the interesting thing is the ones that we were -- we saw the biggest weakness were the areas, I think, you'll actually see incremental. So I do think you'll see it in academia and government, but you'll see it across the board. If you think about what China is trying to do right now, they're trying to build up their infrastructure. And so you're seeing a significant investments in semicon for their own indigenous factory. You actually see semicon being a benefit on both sides of China and ex China. And we expect it to be in environmental and forensics as well as ensuring that the pharma, and particularly biopharma, is healthy in China because they want to ensure that they have access to the latest and greatest drugs.

Speaking of biopharma, so a big factor on the guide cut, went from flat to kind of down low double digits. Talk a little bit about the selling cycle. What's constrained? Is it more LCs? Is it more mass spec? Is it both, right? I think people have picked up on the fact that LC trends in general are about 1%. That's a 7% to 8% growth market, right? So there's clearly pent-up demand on a replacement cycle. So how do you think about that?

Yes, it's a great question. And what I would say is we have seen it. Let's take China to the side because I do think that, that's probably got some different dynamics that we just talked about. But we did see -- we're seeing recovery in both Europe and the U.S., very strong performance in Southeast Asia, I think, as part of some of that redistribution of some of the API out of China into Asia. But it was more broad-based. Importantly, when I look at our LC and LC/MS business, again we're seeing that signs of recovery. So the order performance was much better than the revenue performance. And so to your point, what we're seeing is we're not hearing anyone outside of a few notable exceptions of budget cuts in pharma. You're actually seeing more and more funding coming into biopharma, which is a very good thing. But this time last year, it had totally dried up. We're just not seeing that money released yet. But the budgets have been set. And everything that we've seen is they're not being cut. And so there is pent-up demand. The other thing I would say is you look at our age of our equipment. We've got a great insight into our installed base through our CrossLab business. And our age of our equipment is above the median, which is kind of where it was in 2019. And if you think about fast-forwarding to the end of this year, it will continue to creep up towards that higher end, which would say that there's pent-up demand. And what I'd ask you guys to look at is we've seen it across both small and large molecule. Particularly in large -- in small molecule, what I would say is there's only so much time where you can continue to extend the life of these instruments. There's nothing that's changed in the instruments in the last couple of years that would say something structurally changed in terms of how they use the instruments. And if you look at pill count, pill count continues to go up. Our ACG and consumables business outside of China grew mid- to high single digits, so there's activity happening. And so there will be a refresh of the installed base, the question is when. And we're saying we think it's probably going to be -- you'll start to see it in '24 but probably more in '25.

We've been through a lot of these instrument cycles over the years. I mean, what do you think is the key driver here? Is it IRA? We've seen reprioritization of trials. Is it high interest rates? Is it...

Yes, it's a little of both. And particularly on the large molecule, I do think it is some of the IRA. We've seen that certainly in our NASD business, where clinical trials, the indications have been shuffled around so that they are ensuring that they've got the biggest clinical indications being started first. If you think about kind of what some of these drugs were -- or companies were doing, they were going fast track designation, get the product on market and then build indications from there. Now what you're seeing is the concern about when the clock starts for these products being on market is the first indication, irrespective of new indications. And so they want to make sure that they have the biggest indication going first. So that actually speaks well, I think, for long-term volume, particularly in NASD. But it has required a shuffling of the protocols or the clinical trials and then also patient recruitment, which takes some time. And so that's pushed some things out into '24 and '25. I think in -- on the small molecule side, I do think that higher interest rates have had an impact. I mean -- but these companies are not struggling for cash. They have a lot of cash. You're starting to see actually some M&A activity there. But I think they're being more prudent with inventories as well as their CapEx. But it will get replaced.

I guess, budget flush is another question that comes up a lot, right, as we kind of think about heading into year-end. I mean, how do you think about that dynamic vis-a-vis the replacement cycle? Are they correlated? Do you think the replacement cycle could come earlier, later?

Yes, I do think they are related. If you think about what's happened here, we had very strong growth in the first half of last year in '23. But it was -- I think the entire market was kind of living off of elevated backlogs as supply chain issues had subsided and so forth. So we're into 18 and back half of this year will be 24 months, which will be the long end of a normal replacement cycle. And so again, as we look at budgets, I do think they could be correlated. Again, we're not building that into our forecast. It could be a very late rush, which would be November, December, which would actually be our -- just based on the way our fiscal year ends, it could our Q1 of '25, we would start seeing increased activity. And we're starting to see that in our order book, funnels are growing low single digits. This would be longer term, beyond 6 months. And so there is some reason to be optimistic. Just when did that turn? We were assuming it was happening in the second half of the year, and we're probably saying it's probably closer to first half of '25.

Got it. But in terms of the actual budget flush at year-end, do you think it could be bigger this year than kind of prior year?

Yes, yes. If nothing changes and there isn't a -- what we saw last year was a pullback in the second half of the year from our customers and just reducing spending. If the budgets continue to stay, given the, I would say, muted impact last year of a budget flush, it would be bigger this year, yes.

Let's, I guess, touch on NASD, obviously, so your kind of guidance, the cut implies about $140 million in the back half, so down kind of mid-teens relative to the back half of last year. Can you just talk a little bit about some of the factors there? How concentrated are the issues? Is it one customer? Is it five customers? And what are the factors driving it?

Yes, I would say there's two main factors. I hit on this a little at the very beginning in terms of if we look at the reasons to believe the number of clinical trial programs are much greater than we've ever had. And so that's actually very positive. But we have seen commercial volume going down relative to what we saw last year. I would say you probably know who those folks are. We have had -- there's nothing, I would say, on issue in terms of the efficacy of the programs, they just haven't ramped as expected. So that's the big piece on the commercial side. On the -- and I want to be clear, we're not seeing insourcing or product being diverted from our manufacturing sites. It's really, I think, managing inventory and then on the -- from the commercial side. And then on the clinical side, what you see is we have seen some of that IRA impact push things into '25 a bit. That's much more broad-based, I would say. And what we're seeing actually is probably Q3 is an air pocket. That's probably our lowest and then we're actually seeing an increase to what we're seeing in the first half of the year kind of run rate in Q4. We have all the products, all the orders in hand. Our production plan is locked and loaded for the second half of this year, and we're taking orders for '25 already.

And just maybe just touch on the commercial side, are these competitive issues with the companies you're partnered with? Are they end market demand issues? Like what's really kind of driving that?

Yes, I think you probably need to talk to them more than us. I would say we -- what we can say is there's not an issue with the product and the efficacy of the products that we provide. And I'll just leave it at that.

And I know you had some questions on the call about capacity. I mean, just talk a little bit about kind of the long-term investment in that business. Are you still 100% committed? How do you think about it?

Yes, we're still committed. One of the things that we have here in -- and we've built out Train B, which is the existing train, and we're building out Train C and D. You do lose some efficiency with more clinical trials just because of the number of -- they've got smaller batch sizes and you still have the same level of lot changeovers and so forth. But I think this speaks to long-term liability. The other thing that's really important is when you look at the number of clinical trials but also what the clinical indications are. So the batch sizes and the requirements that we're seeing from customers are larger batch sizes, which would speak to larger customer volumes. So we're in very close conversations with customers. The important piece also is that some people may think that NASD is really focused on small biotech. But customers that we're building these activities for are large and mid-cap biotech. So they're well-funded companies that -- now it's not pay to play. So we're doing it on our own time. They're not doing investment, but we feel pretty good about the breadth and depth. So it's still full steam ahead. I would say if you went and talked to experts, the development services that we provide, the fact that we've been able to go through the scrutiny of a regulatory approval, we are still the gold standard in the market. And oligos are not going away.

And it's still a fairly concentrated customer base you have, right?

It is.

Yes. So how do you think about, I guess, diversifying in...

We are. Yes, yes, so that's the beauty of the clinical trial base. And we have -- the pioneers of this are the Alnylams of the world and so forth, but you're starting to see oligos expand beyond that, and so not only compounds within existing customers but also new customers. And so we have significant -- I mentioned the clinical volume going up, but also the number of customers has gone up as well. So it's not just the same customers with the same programs or different indications.

Maybe we can just touch on capital deployment. Obviously, there's the CapEx side, but you did a $750 million repo. You've got a CEO transition. How do we think about M&A? Is that on the table at all or...

Yes, it is. I think we -- our balance sheet is extremely strong. We wanted to -- on the share repo, we had been doing anti-dilutive for a couple of quarters. And we recognize that there's probably going to be some pressure on the stock. So we're going to be opportunistic and put our money where our mouth is and bet on the future of Agilent. And I think that's going to be a good investment. But it won't preclude us from doing M&A. And I would say our framework hasn't -- isn't going to radically change. We're still less than one turn levered. And I think now there's more opportunities to look for M&A activity in the next 6 to 12 months. And I would say our funnel is very active.

Good. Just on that pacing of the repo, should we assume fairly kind of standard? You wouldn't do an ASR, I guess, is kind of the...

Yes, we're not going to do an ASR or we have already announced that. We are having it more weighted into Q3 than Q4. But if our assumption is right, we're not the only ones that are expecting a change in the market. So we think that there will be opportunities also throughout Q3 but into Q4 as well.

And then just focus areas for M&A, DGG or, I mean, just talk a little bit about where the funnel is?

Yes. I think the funnels across -- one of the things that Padraig McDonnell, our new CEO, has talked about is actually identifying new growth vector or new growth opportunities within the adjacencies of our company. And so biopharma continues to be an area of focus for us. So things like cell analysis, we've had a very successful growth strategy there for cell analysis. I think we will continue to look for opportunities to build out not only instrumentation but content there in other areas of biopharma as well. In select areas of DGG, we talk about NASD, I actually think that there may be some opportunities to look both upstream and downstream to add more value-added services to our customers. So I would say there's a number of vectors that we could look at.

Let's now maybe just touch on margins because I think that kind of got lost in the noise of the guidance cut. But $100 million run rate cost save, you're taking out a decent chunk in the next couple of quarters. Just talk a little bit about margin initiatives and drivers.

Yes. One of the things that we're, I think, very confident about is our ability to continue to drive margins. It's much harder, obviously, when the revenue is not there. But we were able to take $100 million out, actually more than that, roughly $150 million. And we're taking $50 million and reinvesting it in demand generation, things like digital that will also continue to drive synergies. And so one of the things that we're looking at is how to actually become more nimble, operate even better. I think we are a very good operating company. But I think there's still opportunities for margin improvement. And so this notion of 5% to 7% on the top line and 50 to 100 basis points on the bottom line is still intact.

You touched on some newer markets earlier, PFAS, batteries, semis. Maybe just talk a little bit about investments in these markets. Some of these markets are kind of growing 30%, 40%, I mean, real opportunities.

Yes, yes. So I mean, we're super excited about those. And we've been talking about PFAS for the last, I'd say, couple of years now. And I think everyone else has kind of caught on to that train. And we continue to make very strong investments in PFAS. And one of the things that you saw that with, first, starting in water. And to kind of frame it, it's roughly a $250 million business, our opportunity today, growing double digits, started in water and starting to see its way into food. And there's even some FDA regulations that are requiring PFAS-free product that will go into patients and things like that. So you're starting to see it expand even beyond the initial indications, which is great opportunities for us. So this is an area where we're continuing to develop workflows, kind of standard ways for companies to be able to test here. The other one is semicon. I mentioned this before, you're actually seeing it on both China building up their native semiconductor investment or industry as well as investments by governments in Europe and in the U.S. That's a $300 million market. We are, by far and away, the market leader. We have greater than 50% share there. And I think the important piece here is you not only get the fab, so what we do is provide QA/QC for incoming and outgoing product and material. You actually get the entire ecosystem. So it's not just the fab incoming materials, but they actually tell the protocol for all their suppliers to do the same testing, so you get the same results because of the requirements there. And so that's a very exciting opportunity for us, like I said, $300 million. And then batteries, about $200 million market opportunity. And you're seeing that in cars, the investments continue to be made in terms of the research around how do you extend -- how do you reduce weight. And I think that, that will continue to grow as well. And so these are areas that we continue to focus on. And in fact, we just made some launches at ASMS, GCMS that's kind of focused on PFAS and some of these other activities to continue our leadership.

I know we're about at time. Just last one, speaking of big markets, GLPs, your direct competitor in LC has talked about that market. I'm just curious...

Yes, it's a good market. We play in that market as well and both the largest players there and looking for ways to continue to expand that. We think it's a big market opportunity as well.

Great. Good to see you.

Thank you.