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

We're going to go ahead and kick it off. I'm Tycho Peterson from the Life Science team. It's my pleasure to introduce our next company, Agilent. Before we jump into Q&A, maybe Padraig, I want to give you a chance to reflect back a little bit on your time as CEO.

It's been a busy year, but it's been a very exciting year in Agilent. So we've really set out a new strategy, which is market-based. We've a new leadership team, which are working extremely well together, and we have a new market group structure on it as well. So we're well set up in how we're looking out strategy. Then we set off in the Ignite Transformation. I'm sure we'll get into that, Tycho, which is across the company in terms of how we're making ourselves more effective as a company. And in this environment, it's really important as you see with tariffs, that's a real engine that's going to deliver value over time. We deployed $1 billion of capital with BIOVECTRA, which is going extremely well. I'm sure we get into that as well in it. And I think we're very well set up for the future, a lot of excitement. I would say the world around us is changing quite a bit. Our markets were in a lot of really good secular drivers in growth markets, and we've had some really good standout businesses in our first quarter, and we see that going through the second half, that's the year.

Great. Maybe just to look back on last week's results, quarter was above expectations. Book-to-bill was above 1, orders up low-single digits. Everything seems to be fairly solid. No real evidence of pharma pull forward. Maybe just talk about some of the gives and takes as we think about the back half of the year here.

Yes. So we had some really standout results. We beat the bottom and top line in this environment, which I think is just a fantastic. We were able to kind of look at our PFAS business, for example, that grew 70% in the quarter. We see that continuing. That's a modality that's continuing in different areas, different geographies driven by regulation. And of course, sometimes litigation, but a great business for us. Our Infinity III replacement cycle has well and truly kicked off. The system is out 6 months now. So we're seeing that take off and we'll see that continue through the second half. And now our CDMO business, NASD, of course, we went through a reconfiguration with the IRA in terms of the business there, but high single-digit growth, we expect double-digit growth and, of course, BIOVECTRA. So those are the real momentum that we have in the second half.

And innovation has obviously been a theme of late with Infinity, as you touched on. You also have a new GC, the 8850. Maybe just -- you had ASMS this week, talk a little bit about some of the messaging around that?

Yes. So first of all, at a high level, innovation is -- we're turning our guns on innovation, looking at how we can improve and of course, accelerate innovation. We just hired a CTO, Chief Technology Officer, August Specht who has come from Thermo, but a really exciting and he will lead the innovation track in transformation and what's changing for the future is that we don't want to be 2 inches deep across the company in innovation, but we want to be asymmetrically investing in key areas and of course, looking at outside innovation. The Pro iQ single-quad mass spec was launched, great response from our customers, both small molecule and large molecule modalities -- but using a lot of smart technologies that help productivity in the lab. Sometimes people don't think about LC/MS as a productivity system versus LC, but now it's becoming very prominent within labs. Of course, we had released the CRS XF Flex, which is really important cell analysis over time, great response from that outside ASMS. And the 8850 GC with our GC/MS is a critical launch because the combination of that mass spec and our GC is actually going to be critical for new modalities in PFAS, air testing. So currently, in the PFAS market, 2% of that market is doing air testing. We expect in the next 2 to 3 quarters that's going to move to 8% to 12%. And GC/MS is the technology that's used in that, and we generally have a 50% win rate. So we're very excited about that.

We touched a minute ago on the quarter you just reported. Book-to-bill was above 1. Orders up low single digit and Europe mid for the first half of the year. Maybe just talk about the key areas where you're seeing strength in the order book. And what gives you comfort you are seeing pharma pull forward? I mean that's been a question I think every company has gotten throughout the earnings season.

So it's our fifth consecutive quarter of book-to-bill greater than 1 actually instrument book-to-bill greater than 1. So it's a continuation of what we've seen. And if you go back in terms of markets, '23 was a really low point in pharma, improvement in '24, really improved in the second half, and it continues to improve. So we were very pleased with it across the board. CDMO business doing extremely well. Infinity III and really doing well under replacement cycle. We did not see any pull forward. We did see a minor pull forward in consumables in China of $15 million. It actually has worked itself out almost immediately. So that's been very good to see. We did see a slight disruption in China around instruments around customs in terms of delivery in April. But again, that's back to a baseline. So no pull forward. And when we talk to our customers, and you talk to them about their fleet and the improvement in pharma. They're in a steady replacement cycle there, of course, you have reaped the possibility of reshoring in time. That drives a lot of conversations about how we're going to address that, but no pull forward.

And you had the benefit of having April in your numbers relative to your peers. Was there any difference or pre, post Liberation Day?

No, not really. I mean if you talk to our customer, we have a strategic account program where we are at very high levels in pharma. Talk to our customers, we expect that maybe some discussion around tariffs -- and of course, pharma, we're moving supply chain and inventory around, but that doesn't really affect our testing. It's the same amount of testing. So that was really steady. The only anomaly we did see was around the instrument orders in China giving the delivery times with our -- with the customs and the free trade zone that took time for people to process those orders.

And I guess, honing in on LC/MS, how do we think about the back half of the year for that part of the business in particular? And how much could you actually get from Infinity III.

Yes. So for LC/MS, we are largely in the QA/QC or downstream environment. That's an area where, of course, I think in this environment continues to be strong and will continue to be strong. the productivity that we're hearing from our Infinity III launch, which makes it 30% more productive in labs for customers, which is a real resonance and linked with the Pro iQ single-quad it really means that we're going to continue to accelerate not only the replacement cycle, but also new labs that are being set up in different areas. .

So do you think this is a driver of share shift within...

Yes. I mean share shifts generally don't move a huge amount. In LC, you've seen it over the years, Tycho, it's pretty stable. You have the 2 main players, which we are 1 of, and then you have players on that side. But we have been extremely pleased with our market share gains. We look at our [indiscernible] report, which is our market share report 3 months in arrears -- but it showed across those product lines that we're still gaining share. So I think as the pie grows and as this replacement cycle continues, we'll continue to keep that position.

Maybe just spend a minute on ACG -- up 9% in the quarter. There are some timing-related elements. I think, 2% or so. So you're up maybe 7% backing that out. But -- just talk about the momentum you're seeing on the ACG side. Obviously, U.S. academic and government is piece, but how are you thinking about that as well?

So ACG, 9% growth in the quarter. And we, of course, reconfigured that group to now have services, consumables, software and automation, which is a really important enabler for the business on it. 70% of our contracts are our service businesses on contracts growing double digit, which is really sticky. The areas where we see immense runway going forward is around lab productivity. Our enterprise service business, which is now $150 million, which means we can service all competitors' equipment and run their labs from a productivity standpoint. We see that resonating and actually accelerating through the year and continuing on. On the consumables business, as I said, there was a slight pull forward on it, but we were still mid-high single digits even with that pull forward on it. And as I said, we've seen that already stabilize out. So ACG is a really important growth driver going forward. And if you look at our long-range plan, that 9% growth is higher. So it's one of the areas that we can continue to expose.

In the academic government smaller piece, but what's -- it's a dooming gloom for NIH, obviously, but how are you thinking about that?

Yes. I mean I've been out with 2 major institutes in the last few months, and it's not nice out there in terms of funding. It's 1% of our business. Academia in general, for Agilent is 8%, 3% for the Americas. I would say, let me talk about the market in general in normal times. It's generally low to mid-single digits over time. I think it will go back to that. Clearly, U.S. is very depressed where no big capital equipment has been really spent on. We're less exposed because we're not in the higher-end research type of modalities, but we still see it -- see a softness -- and we're expecting to see that continue. We've ring-fenced that for the rest of the half. We're expecting it for -- to decline 20%, and we've mitigated around. I will say in the rest of the world, Academia is doing just fine. We've seen growth across different areas, and we continue to see that. What we're -- of course, the NIH funding is going to have a knock-on effect on innovation particularly in biotechs and so on. So I think over time, that for me is the broader concern. But I would say with pharma, that wouldn't have any big impact for a few years, I would say.

And Tycho, maybe to add to what Padraig is saying, 1 of the benefits and beauties of the ACG business is it truly is across all of the end markets. So if you think about the end markets there, it's really 50-50 kind of life sciences and applied. So we have the ability to cover all the labs, and we're seeing strong connect rates to these new products that we're offering and a big opportunity to continue to drive that growth.

And just 1 question to follow up on that. As we think about the academic kind of belt tightening budget pressures, I mean, people obviously think about instrument delays, but -- are you seeing switching to third-party columns, switching to third-party service providers? Anything beyond kind of just instrument pause.

Yes. Look, the topology of the service business and Academia is quite different, right? So you get a lot of self-maintainers, PhD students that are can help run the system. So there's less contracts, I would say, more per incident. Contracts are generally sold upfront. So we still benefit from those contracts, but very little switching on the chemistry side, I would say, on the supply side. Yes.

And then maybe talk about the organizational changes you just mentioned within the ACG business, centralizing automation and software. What was the rationale were you hoping to accomplish.

Yes. It really started with strategy, Tycho. And as we laid out on our Investor Day, in December. The 4 pillars of our strategy are really clear going forward. It's market-driven. First of all, it's increasing innovation, that's external and internal. Secondly is attaching to high-growth markets. Third pillar is really automation and productivity. It doesn't matter what lab you are in the world and what market automation and productivity is right at the top of the agenda, and that's why we elevated it up to that area and the fourth area is software. So those 2 last pillars, we really felt to have an enterprise group that's working across all product lines and all areas to really help with that was the right thing to do. And I have to say it's allowing us to make much faster allocation decisions, both in innovation, but also it's honing our ability looking potentially outside for opportunities. .

Maybe just shifting over to NASD. You've got real momentum here. I think you're even taking orders for 2026. At this point, talk about just visibility and demand, confidence that you could kind of potentially move numbers higher. I think easier comps in the back half of the year implies something like 20% growth to hit the 10% for the full year. And then on clinical versus commercial, you're now 60-40. I want to make sure that's commercial outgrowing as opposed to clinical.

Yes, yes. So I'll start off and maybe hand over to Bob on this one. We grew 9% in NASD. We're expecting double-digit growth, high single double-digit growth for the year. We're booking into '26. We're booking out that capacity. We're seeing a lot of demand in terms of the clinical versus commercial shifts, that's not an either/or. We're just very pleased with the projects that we have in commercial, and that's going to, of course, move on through the different years. So overall, we're well poised. I went through a very difficult phase, of course, with the IRA rebalancing but the energy around our customers and the partnership with our customers going forward is very strong. But Bob, I don't know if you want to...

Yes. Just to build on that, Padraig, when we look at the second half of the year, we feel very confident because we have the orders in-house. So we have the ability to do that. And as you said, we're already booking orders into '26 and beyond. And when we think about the commercial volume, it's really -- what that allows us to do is actually have diversification across the programs. We have basically a little over 50 programs, both in clinical as well as commercial. And our client base continues to expand as well. And so -- you add those 2 things on and then you look at the therapeutic areas that we're actually going -- our clients are going after, it's actually larger patient population. So that's why we're being able to see the skew towards commercial net outs to diversify our business and actually gives us confidence about why we continue to invest in capacity expansion in NASD. And then you have the benefit, and I'm sure we'll talk about this of being able to leverage the capabilities that BIOVECTRA has combined. And so we're very excited about the NASD facility. You're right. Your math is right as usual. It would be 20%. We do have a benefit of an easier comp in Q3. That was when -- but we're actually seeing strong momentum and expect actually sequential growth Q3 to Q4 based on the production plans that we currently have in place and would expect that momentum to continue into '26 and beyond.

Are there margin implications that we should be thinking about as commercial outpaces clinical?

Yes, it's a really good question. If you think about the facility. This is one of the areas where we do have a high level of fixed costs. So the more production you can actually run through that plant. The incrementals are quite accretive to the company. And so commercial allows you to do 2 things. One is you have a more steady volume, but also the batches are larger, and you can actually campaign those batches lots at a time, so which is very efficient in the factory. So we expect this -- it's already an accretive business to the overall company at the operating profit. It's lower gross margin just because of the different business model. But as we think about more commercial filling that plant, the more efficient that plant becomes, the higher the operating -- the incremental operating profit is. And that's one of the reasons we feel confident about continuing to drive margin expansion -- into '26 and beyond.

And maybe just thinking about CapEx a little bit, $450 million, I assume about half that's NASD. I mean how do we think about run rate CapEx.

Yes, it's a good question. So this year is kind of our peak year of investment as we're building out that facility Train C and D. We will have some capacity, it will step down in '26. And then become more of a maintenance CapEx. And when we think about maintenance CapEx, it's usually about 2.5% to 3% of sales for the company. So we've had a step-up above that to take advantage of the capacity and the opportunities here in NASD -- and we would expect us then to be able to fill that capacity over the end of the decade and to be able to leverage that going forward.

And just, I guess, as we think about capacity expansion, you mentioned Train C and D, but just in general, how much of this is built and they will come versus kind of a bottoms-up analysis where you've kind of got some of that already committed as you move forward?

Yes. I think, of course, we're -- as you get into '26, you get close to your very good line of sight. You're always beholden in terms of some of the therapeutics moving ahead, but we're in deep relationships with the customer. And that commercial I would say, a move up to 60% is a really positive momentum on it. So we're not just building it and waiting for them to come -- we're expecting to fill that out.

Yes. You can imagine that we're having those long-term conversations with our customers because they also want to ensure that they have capacity available when those products do, in fact, hit the market. So -- we do have a very robust funnel of opportunity. Obviously, not all of those are going to make it. But when we look at that, we actually discount it in order to actually size the opportunity. So that's one of the benefits of actually being in the NASD business is actually a much deeper relationship with our customers downstream. So we've got relationships already kind of planned out toward the end of the decade based on the opportunities that potentially could come forward based on the discussions that we have today.

I want to pivot to China and maybe just spend a minute on what you saw in the quarter, just unpack some of the trends. How are you thinking about it for the rest of the year. We kind of assume $300 million per quarter or so ex stimulus. Is that the right way to think about it? Or is there a path to accelerate that?

Yes. I mean China is really interesting. I mean, if you look at the pace of innovation there and everybody can see the number of clinical trials and molecules that are drugs that are coming out. Let's talk about the longer term, that pace of innovation will need [ tools ] Now the question is, of course, made in China and et cetera, we'll get into that. But we've seen this very stable business in China. The stimulus was highly successful for us in the first round of the GACC. We won 50% of $70 million. There's a second stimulus coming on. But what's really important in China during this tariff has been a tariff situation has been really close to the customer making sure that your manufacturing is on point and making sure you're keeping very close to competitive moves in China. And our long history in China, our technical expertise in our Made in China makes us very resilient in this environment. Now it's a very difficult market. So I don't expect it to rebound in the second half. But over time, I think this market will become a high mid- to high single-digit grower, not back to where it was. But our capability there is very important. And the second stimulus is probably another area. We're getting good luck on on that. We're thinking it's about $120 million. It's broken into 3 areas. Its first area is the administration regulatory body. The second area is the second GACC customs and the third area is EPA. So our funnels -- we're looking at our funnels on that, and we're seeing that we'll probably be revenue in Q1 orders in Q4 -- and that's not in our guidance.

And are you assuming similar win rate?

Yes, a little bit different because our win rate was very high in GACC because of the topology of the instruments. It was about 50%. This, we expect lower probably about 30% just because of the topology between EPA and the AMR section, but still a very high win rate, much higher than our normal win rates. .

I think is it 10% of the first orders went to the Chinese companies. Is that about right?

Yes, about -- yes, you're correct. So when you do the tender, you see everybody's performance, you see who submits about 10% lower end equipment, I'm talking about molecular spectroscopy, GC, about 10%.

Okay. And in general, is that where you do see local substitution...

Yes. I mean -- and by the way, that's nothing new. We've seen that probably for the last 5 to 7 years. I mean we compete with local Chinese companies on the lower end, but we compete extremely well and we watch it very closely for competitive moves.

And one other thing I think is important, Tycho, on that is one of the requirements to be able to bid is actually being able to produce the product in China. And so we've got probably one of the most extensive in China for China opportunities on the platform side, which has enabled us to be very close to not only our customers, but drive that win rate as well.

Got it. How about the drug industry in China, China generics? How are you thinking about that? I mean your exposure overall.

Yes. I mean we have a very good exposure in QA/QC, I would say. That was a part of the market that grew extremely well over years, and I think it's been challenged currently, of course, with some of the moves outside China and Asia, but we expect that to come back. About 80% of that is private, 20% kind of government-owned and we see a lot of runway. But you just need to look at the announcements with the partnerships with pharma, the co-marketing agreements and so on, and our tools are really critical in all of that. I would say about China, though, it's not only about pharma, Tycho, PFAS, 2 quarters ago was our fastest-growing region. We continued -- the business has actually doubled in China. So if you look at the China strategic plan around safe water, food and now, of course, PFAS a really important business for us. And of course, semiconductor and batteries in our chem business. We had a little bit of, I would say, a subdued demand this half, but looking at the market and the equipment market for semicon and high-purity chemical plants around semicon and actually batteries China, we expect next year to be -- to have a real tailwind on that.

And I guess just thinking about PFAS overall, like there's been, I think, new regulations around drinking water out of the EPA here. Do you see that business accelerating?

I mean it's -- we're working through that at the moment. First of all, there's some discussion about less molecule has been tested or less parts of PFAS, but the number of tests will be needed. But there's no doubt about it, it's going to continue here through regulation and continue globally through regulation. Actually, a bigger part, 1 big emerging part of the business here is litigation, polluter pays. So litigation is driving a lot of testing -- and a little known fact, every semiconductor fab, every high-purity chemical company around those fabs are all testing now for PFAS on the inflow and the outflow. So we get a significant business around that. So as regulation changes, as it moves to air and as it moves to different modalities, we are very well positioned. That's why we really believe we're in the early innings of PFAS on the curve, and we believe it can grow to $1 billion opportunity in the market in 2026.

I think one of the things that we're really seeing and really excited about is if you looked at our Q2, you said it grew 70%. It's tracking to well over $100 million on an annual basis. It added 80 basis points to our growth. And if you look at it, half of the business now is actually outside of the environmental and forensic market. And so it actually shows the expansion into Food and Chemical and Advanced Materials. And the air opportunity that Padraig mentioned, we're uniquely positioned because that's GC and GC/MS. And so we have an outsized share in that market. And so we're very excited about the long-term growth opportunities in PFAS.

I want to touch on pricing quickly. I think you'd originally talked about 100 basis points, maybe it's a bit more now with tariff surcharges. Talk a little bit about traction with pricing initiatives -- how do we think about gross margin lift in the back half of the year?

Yes. So in pricing, we did 100 basis points plus in the first half. We have an initiative in Ignite enterprise pricing. And to kind of bring into how that's different. So before every individual product line would have set pricing. But now we're looking at the enterprise level, and we're putting more tools in the hands of the sales force around profitability, not just on 1 product line, but a suite of offerings. So it allows us to really advance our price. I mean this year, we've taken more price already than the whole of last year. And we continue -- of course, there's a headwind with tariffs, and we continue to see it. But we expect our pricing initiative to really gain traction over the next 3 years in Ignite it's a new muscle that we've developed.

Yes. And as you said, on gross margin, the second half because of the tariff work that's going on, margins -- gross margins are probably going to be flat sequentially. We were expecting an improvement. But going into '26, we're expecting full mitigation. And so we're actually going to avoid the tariffs through the work. We're already starting to see that through the movement of the supply chain, but it will scale up through the second half of the year. And so that's where you'll actually start seeing re-seeing some of the margin expansion into that, coupled with the pricing and then some of the benefits around volume as well.

And I guess as tariffs have kind of gotten dialed back, are you kind of recalibrating any of those moves or...

Yes. I mean we went into this with a very strategic view about what we're no regret moves. Actually, we started 9 months before the tariffs were announced at optimizing our supply chains. Like for example, we were -- already had plans to move our LC production or have similar LC production in Delaware in the U.S. I think in the long term, if you think strategically, we want to be close to our customer with manufacturing. We want to be in regions -- so there is no, I would say, movement different or different moves if tariffs go up and down. Of course, around the edges, we'll have to see if there's a big difference between 1 country and another -- but I have to say, I'm extremely proud of the team. Our previous record for moving supply chains was 3 months. And under the Ignite transformation, we moved 6 weeks for 1 supply chain. So we're -- we've built a lot of capabilities around that.

And I guess, Bob, how do we think about that flowing through into operating margins next year? I mean, at the Analyst Day, you talked about 50 to 100 basis points kind of longer term. Could next year, you overshoot on the back of pricing and...

Yes, certainly not giving guidance yet, but there certainly is an opportunity when we think about the momentum that we have on pricing as well as some of these supply chains. Now you could ask, well, by duplicating supply chains, does that actually increase your cost that's actually where Ignite actually comes in and really helps us because one of the other areas that we've been looking at is how do we look at our supply chain in a very rigorous process around manufacturing excellence. So we've redoubled down a continuous improvement opportunities on a plant-by-plant basis. We've done 3 plants to date. We're expecting to go through many of the other plants going forward and that's actually going to drive cost down. So anything that you would say, hey, maybe there's some incremental costs associated with this, we're going to be able to offset that and then some going into '26 to this manufacturing supply excellence activity. And so we do have some mix dynamics there with NASD and the services being lower. But if you took that out and looked at it on an apples-to-apples basis, we do expect margin improvement on a go-forward basis, more so in '26 and then even potentially even more in '27 as these things get fully ramped and annualized.

Yes, maybe just to add quickly, Tycho, we've taken out $130 million in annualized costs with -- through Ignite this year, $80 million through organizational health and about $50 million through procurement. They are only 2 tracks of a 13 track. Not all of them are margin, some of them like are, of course, based around growth. So we've got that priced out for the next 3 years and also incentives in the company based on that. So we have a high degree of certainty.

Maybe in the closing minutes, we'll hit on capital deployment. We were chatting before this about how investors think there's going to be consolidation in the space. I mean how are you thinking about M&A? And are there areas you're prioritizing?

So I kind of laid out the 4 pillars of our strategy. It's going to be based on strategy. It's not going to be what company is available in any particular time. If you come into our discussions in Agilent you would see a small list of very high-quality assets that are linked with our strategy. We have a leverage on our balance sheet is very strong, and we are going to be doing more allocation towards M&A going forward. But it will have of course, the financial hurdles that we would have to do, but it will be really driving us into faster-growing areas and expanding our recurring revenues. So lots to come in that space.

Has the volatility brought stuff into your kind of field of view that may have been out of range out of scope before from a valuation perspective.

I mean valuations in general have come down quite a bit. There is a lot of talk around consolidation around the mid cap. We're not reacting to any of that talk. We're very focused on our strategy. But definitely, the valuations are helpful. .

And any view on kind of products versus services from a high level?

Yes. I mean if you were to kind of -- if you look at our strategy, what we're really interested in is opening or recurring revenue. So it doesn't mean we won't look at key products that are going to help drive the pace of innovation -- but clearly, more content and areas about recurring revenue around services are important to us because we already have a really significant engine in services more content and areas about recurring revenue around services are important to us because we already have a really significant engine in services and also a really significant commercial engine that we need to put more things into.

Great. We're out of time. So I think we'll leave it at that.

Thanks, Tycho.