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

Please welcome from Agilent Technologies Padraig McDonnell, Chief Executive Officer; and Adam Elinoff, Chief Financial Officer; interviewed by Casey Woodring at JPMorgan.

Thank you, everybody, for joining us today. I'm Casey Woodring the life science tools and diagnostics analyst here at JPMorgan. I'm pleased to be joined by Agilent's management team, CEO, Padraig McDonnell; and Elinoff, CFO. Thank you guys for joining us here. I know it's a long trip away, away from home. Maybe to kick it off, Padraig, we've seen strong results the last couple of quarters, leading to upwards guidance revisions on both the top and bottom line. Maybe could you just speak to the structural changes that you've instituted at Agilent since you announced the nice transformation in late 2024. And as you look at the momentum that you're seeing across the business here, how much of it is simply a function of better end market dynamics versus specific Agilent or -- dynamic specific to adjuvant? .

Yes. Thanks, Casey. Thanks for having us. So as you see markets steadily improving, what we've been doing over the last 2 years is really compounding our capability with Ignite, which has moved from a kind of a transformation to an overall operating system change. And that's how we're allocating resources within the company, how we're -- assets around our operational business and also how we're looking at innovation, and that is really showing true in the numbers. But I think if you go back and you look at the 2-year stack, if you look at our growth rates, 2 years ago, it was like literally flat, but now we're up to almost 10% growth, 11% growth. Our operating margin expansion is over 100 bps. And again, that's in the face of a lot of tariff headwinds, again, driven by the capability we've driven. EPS. Again, if you go back 2 years ago, it was a 3% decline, '25 was 6% growth, and now we're 10% on the EPS side. And again, we had a tax headwind on that side. So if you look at -- you see the progression over the 2 years, you see that we're compounding our capability in a very way. And I would say that it's not only end market improving, but you're seeing -- we're seeing a true share gain, seeing it through the innovation we're getting. And of course, you're seeing replacement cycles, et cetera, driving this growth. And in the next phase, as we built a company in the last 2 years with our capabilities, the next phase is where we bring this right, and that's largely around this idea of what we would think was going to be defining the next decade in our tool space around autonomous lab and scientific intelligence and how we're putting our capabilities to bear on that. And we have an extremely strong right to win and how we're putting our dollars on innovation on that side. And then you look across our markets. Our markets have been really improving to continue to be very strong. We're in really good sections of our markets, whether it's pharma, CAM and our diagnostics is doing extremely well. So what I would say is we're extremely well set up for the next phase by the choices we met in the last 2 years.

No, that's helpful. A lot there that to get into later on. But maybe just starting with fiscal third quarter results. You reported a strong quarter. One of the highlights for us was the performance in China right, double-digit growth in pharma and food, high-teens growth in Advanced Materials, all in the region there. Can you just expand on the strength you saw in China? Similar question to the opening, how much of that strength was really market-driven versus agent-specific dynamics, share gains. And then you noted we raised the guide for China and 4Q. So how much of this is really sustainable?

Yes. And just having come back from China a month ago, it's great to talk about it. It's a perfect timing. We've decades-long history in China. We have a huge installed base in China. We've had manufacturing in China for almost 3 decades. So we had a lot of capabilities. And I'm just back from China where I opened a new innovation center that's going to be really at the heart of where you see physical automation that's going to really help. And China, for us, it was broad-based strength. You saw it across all our markets, small molecule biopharma and also testing laboratories and food and environmental, which is core for us. And the things that, again, when you look back and why we're doing well in China, improving conditions, but we're not calling an inflection point yet. Why we're doing so well in China, it's because of the capabilities we put in place. We haven't gone indirect. We've kept our technical teams there really close to our customers. So as budgets are released and so on outside stimulus, we can take share and have played out very well in the quarter. We're extremely excited with the future of China. I mean China, long term, is going to be a mid-high single-digit grower for us just the pace of innovation. And I'm sure you saw the announcement on the 15, 5-year plan as it relates to pharma. Just to put it into context, pharma market in China overall business in China for the macros is about $250 billion, and we expect to grow that by 2% over the next number of years. And how are they going to grow that? We're going to grow that through manufacturing, innovation, but also thinking about laboratories over those times. So if you're a trusted partner in China with these type of macros going forward, it's really positive. And I think we're going to continue to invest there. And then you look at chemical and Advanced Materials, where there's a lot of investment, semiconductor and other areas, battery over time and then our testing areas. So we're very broad-based, but we're really excited about the future in China. .

And then another highlight in the quarter was the continuation of the instrument replacement cycle, low double-digit growth in LC. I think it was the tenth consecutive quarter in a row of book-to-bill above 1. So can you just elaborate on what customer segments are driving strength in LC which customer segments have seen replacements accelerate, which have yet to see the replacement cycle kind of really start to kick in? And then maybe just talk a little bit about how the order book has been shaping up there. .

Yes. So it's another opportune timing just arrived from Germany last night, we're in our R&D center for NCE. We're everywhere. We were in our R&D center where the Infinity III was developed and where it was developed over a number of years. And of course, we have our some cell analysis products there. And what really struck me was how our innovations are resonating and I'm talking to the teams about how the Infinity III was really around customer productivity. And if you see in the in the world of productivity and AI, you need the tools that are highly productive around this. So the replacement cycle, I would say, if you can think we're less than halfway through that. You can see our quarters over the last number of quarters doing extremely well, double-digit growth in the last quarter on LC over a tough compare. So we're less than halfway through that. And what I want people to really understand is our installed base is very large, but also we have a competitive installed base to go after for many different vendors. And we're seeing that we're able to be very successful in those -- in areas where particularly people are looking at productivity. So as the replacement cycle is going to be 200 to 300 basis points is going to add to the overall business. So we're going to see that continue on, but we're less than halfway through. And then what we're really looking at is as these new systems come in and as they're put into laboratories, it all doesn't happen at once, right? So that can be sequential over a number of quarters in 1 area. You're seeing that we're looking at our consumables and our service connect rate over time about how that improves on those new systems. So it's an accelerated on Connect Rate, which is very important. Then what is not often talked about with us because our portfolio is much broader than just the GC replacement cycle is really humming along We're probably 1 quarter away through that. We have a lot of room to grow in that around chemical and energy, lots of [indiscernible] systems out there. So -- and again, that's about 100 basis points improvement on the overall business. So that's going to continue on it. And again, what underpins a replacement cycle is actually our service capability and our enterprise service capability. So 1 of the reasons customers switch is actually about your service provision. It's very simple when you think about it. But if you're not able to run sites very clearly on your service side, the replacement cycle can be very different, but it's 1 of our key strengths.

Got you. You mentioned AI in that answer there. It's been the topic du jour of all tools investors for the last few months. Maybe just walk us through kind of where Agilent plays in the whole lab automation and wet nab validation exposure. Are you expected to see some of these volumes flow through into Agilent near-term benefit, maybe longer term. Maybe just walk us through how you view AI build-outs.

Yes. So we're spending a huge amount of time in the company thinking about how do we consolidate our resources around autonomous lab and scientific intelligence. And of course, AI is a key enabler on that. One thing that will always be needed is trusted answers from a too. So people can think of the analogy where the tool is like the eyes in the laboratory the automation or the physical AI or like the hams and then the agentic layer is like the brain doing experiments on the systems. So the need for tools will only need to expand as AI comes in from our customer point of view, there's more need for testing. There's more need for release of drugs. And you hear from large pharma companies how to reduce in clinical trial times but also setting out very broad goals about transformative molecules that will be brought out in every year. And I think the interplay between development discovery and QA/QC is going to shift a little bit. you're going to see development be more important, actually, and then you're going to see QA/QC be more important even than that. So talking with our farmer partners, AI is certainly speeding up what we're doing now for our side. The first manifestation of that is the autonomous lab, and it is in the broader scientific area. And that's where customers are wanting to do more autonomously in their laboratories over time. And there's really a future and path with this. So we talk to our number our top customers, they have lighthouse autonomous lab organizations looking at how they're going to kid out labs in the future and it's very much co-creation. It's not about like getting the specifications on an LCM and going to bring out a more sensitive at. It's about how that productivity and workflow is going to increase. So we're working with these companies, and we've created a group in the company under our CTO office, August office, where we have an autonomous lab group that is heavily linked with our AI group that we've built out. And these capabilities will be gradually brought into customers as we co-create them. Now you see it currently in the QA/QC labs where the agentic layer will be used more and more but you're going to see that actually speed up as you see physical AI being used on the systems. And it actually changes how you look at the future in some ways. You think about automation ready instruments, not just just instruments as they are. But also, we're very, very focused on how we can grab value streams around the tool. So that scientific intelligence layer is really important. That physical automation there is really important. And that will be done through partnerships, some M&A with capabilities we need to bring into the company, but it's something that we're very deliberately working on.

That's really interesting. I want to dig into Advanced Therapeutics, the specialty CDMO strong growth in fiscal third quarter, 30%. I guess how did that compare to expectations? Were there any sort of one-timers or pull forward in the quarter given you do assume a step down in growth in fiscal fourth quarter here in the CDMO and then just maybe along those lines in the fluctuations there in growth. Can you just talk about the visibility over the kind of medium to longer term there? I understand that it could be a year on a quarter-to-quarter basis.

Yes. So I'll start off and hand over to you Adam. So we grew 30% in the quarter. That was in line with expectations. In Q4, we were flat, but that's kind of in line with what we see with some regulatory filings, et cetera, but it was over 40% compared in the previous year. We feel really good about mid-teens over the long term with this business, and we can see that through our pipeline with customers and how we see it. If you think about train C that's coming online next year as a kind of an example. We have 75% of Train C booked out for next year. And the train C lends itself to more commercial batches from clinical. And over the last number of years, we've moved from lower commercial batches, but 60-40 on commercial and clinical batches, and we see that continuing to grow on it. And we're not beholden to a number of a few customers. We have a broad range of customers that would be filling this capacity over it. So we feel really good about it in the short term and in the long term.

Yes. I mean I think Padraig covered it nicely. I think the only piece I would add is we do have good visibility into our medium-term forecast. We have customers take time to develop their processes, et cetera, and then they put in their forecast. So it's not based on any 1 or 2 changes in a near-term period that impacts us. The second thing I would highlight, which I think is underappreciated is actually the cross-selling that happens between our CDMO business or ATD and then our instrument business. And so there's -- it's similar customers in the same customers and [indiscernible] to cross-sell, which is a nice feature of the business. .

Okay. Yes. Maybe just sticking on those lines, you mentioned Train C coming online in the second half of next year. I think you guys have sized the peak revenue generating potential there of around $300 million. Maybe just walk us through, I think you said 75% is booked already but how should we think about the contribution from Train C in the back half of next year, understanding that there's some variability in the types of programs that that come online and the timing of that.

Do you want to take that?

Sure, I'll take that. So I guess a couple of pieces. The first is Train C will come online in the spring of '27. And the way we've articulated the full growth of Train C and D. Train C will take about 6 to 8 quarters. Train D will come online a couple of quarters after and then take another 6 to 8 quarters to continue to reach full capacity. When both are running full capacity, we would roughly double. So about $300 million-ish, but we're getting out of the the site today. A couple of other pieces I would just add is that. [ Core ] talked about the 75% line of sight. And then the thing you have to think about is the existing capacity will start to fill up in the beginning half of the year and then the second half of the year, the incremental revenue will become growth. So it was planned very nicely to come online almost at the perfect time. So I'm excited about that. And then the last piece is, as Padraig talked about, is the mid-teens growth that we expect over the near term for the business. So we feel very good about it. .

Yes. Maybe 1 last 1 just on the confidence in that assumption. We've seen a couple of prominent negative late-stage clinical trials in the space over the last few weeks even. So I guess, how do you kind of risk-adjust for those different programs that might be in your backlog or what have you? And just what underpins that confidence in CDMO long-term growth rate because I just want to get more .

Yes. So the way I think about it is this, and I think this is a helpful number. So in 2019 we have 3 customers that made up 80% of our demand. And now we have 3 customers make up less than 50%. So we're gaining diversification as we go. The second piece is we have a healthy mix of commercial and then clinical in '25, we're 60-40 commercial clinical, and that's starting to ramp. The commercial side, you always want to maintain a certain amount of clinical because that's your pipeline into the future. A couple of other pieces is the recent news doesn't impact our forecast for 2027. We continue to love the siRNA space. I mean you look at the pipelines out there, they continue to grow, and there's a number of molecules ranging from that rare where they've been mostly today moving into larger indications across different therapeutic areas. So we're excited about the investment and the process and the progress of the site continues to go very well right on plan and excited about going online next year.

Full steam ahead. .

Yes, full steam ahead. .

Last 1 on Train C, but just we haven't touched on the margin implications, right, of the buildout. I think you previously talked about additional hiring in the first half to accommodate Train C coming online in the back half. How should we think about the CDMO margin profile in 2027 in the context of that kind of 50 to 100 basis points long-term guide of the total company. .

Yes. So a couple of pieces. So as it's coming online now, no impact to '26. '27, it will be dilutive, of course, but we've committed to our 50 to 100 basis points that you have in the continuing to deliver that, and it goes back to Padraig's first comments about the Ignite operating system. And what we've done is we've seen this coming, we've seen the dilution coming. So you have to hire, you have to start to depreciate the asset before you're getting full capacity, but we've been planning for that. That's something we can see into Ignite, we will offset that.

Yes, we're very confident on our 50 to 100 basis points plus. .

Got it. Okay. Maybe circling back to the LC replacement cycle that we talked about a little bit earlier. I think this has been a multiyear cycle, you've talked about like a 3-year time frame. I guess are there any broader geographies or customer segments that have really yet to engage at this point?

Yes. I wouldn't say -- I mean, all geographies, I think China probably is an area where the fleets are older and haven't been replaced post COVID. So that's an area where we expect to see continuation accelerate. But I think it's very broad-based. But I think it's important for people to kind of understand that we have such a very different age of systems in our installed base and competitors of the different very age of systems. So it's more about that than the actual geography that makes any difference in it. And of course, when you have an opportunity in a replacement cycle is a competitive moment. You have a situation where some people think sites are 1 company and another site as a separate company, but actually it can be 50-50. The left-hand corridor can be 1 company, the right hand corridor can be another company. And as that replacement cycle happens, then it's a highly competitive space where you have an advantage to take some share. So I would say it's really broad-based, and we're continuing to see it expand. The LC replacement cycle is roughly 7 to 8 years. We're less than halfway through it at the moment.

Okay. And then within the context of instrument growth, just putting the replacement cycle aside, you talked about share gains over a number of different quarters here. Maybe just dig into that a little bit, where are the share gains coming from? Is it a technical aspect of Infinity III? Is it commercial execution via Ignite, something that we're missing kind of .

Yes. Look, it was our strongest, what we saw in the [ Proteo ] our strongest share gain that we've ever seen. And again, people think that's just against maybe 1 competitor or 2 competitors. There's many competitors you can gain share of out there in the market. I would say what was really strong at CMS spectroscopy was strong. We saw some amazing results in certain regions. But overall, it was very broad-based. And why is that -- like why is that happening? It's happening for a number of reasons, is that commercial engine that we've built up over a number of years and went from strength to strength on it, but also that service capability that underpins that it's the #1 switching reason, by the way, for any company is around our service capabilities. And then we underpin that with our enterprise service business where we're running laboratories. So we won our systems and other vendor systems in an asset management way. So we have a very high level conversation in those laborers. Now think about that in a market share situation, you get air visibility into problem assets or assets that need to be replaced over time. So you're at right at the heart of that decision-making and that really helps with share gains too.

In the LC business, but I guess just more broadly speaking, I would be curious to hear if there's any read-through from the Merck and Moderna data to your business with that data seemingly lifting sentiment on that entire drug classes potential? .

Yes. It's very compelling for analytical tools. In Germany, again, I was looking at some other cell analysis equipment, and it's really right in that space. So it's very, very positive. We do think it's going to be positive in our CDMO business. We have capability around that area on it. So I would say we have a dual tailwind around that. So we're -- and some of our innovation programs, interestingly, when I was looking at them on our instruments during the week in Germany, A lot of these instrument -- a lot of the innovation was around mRNA in some of those areas and some of those technical abilities. So I think we're going to continue to launch products that are going to have to fill that space.

Okay. Maybe shifting to GC you talked a little bit about that replacement cycle as well. I'm curious, is this replacement cycle different in GC given all that we've seen around semi demand with these fab build-outs and so forth, reshoring -- is there anything different about this replacement cycle in GC related to that? .

Yes. So it's -- again, we have probably the largest installed base of GC and GC/MS globally. And it's broad-based around our chemical and energy customers. You can see it in our food environmental, but we have an extremely strong presence in semiconductor fabs. And people think of a semiconductor fab as it's GC, GC/MS spectroscopy but around those fab high-purity chemical companies that are actually need our tools and then actually they buy more tools in that case. So that replacement cycle is kind of dual in terms of new technologies on the spectroscopy side that is replacing our 9500s replacing on the fab side. But on the GC and GC/MS side, there's always a replacement cycle there that's slower. Generally, we see the opportunity 18 to 24 months before it. So it's a longer run in. But when it happens, it happens across the board.

We talked a little bit about replacing dynamics fueling growth in LSD and AMG here, but you mentioned it service earlier, I think it does create a little bit of pressure the replacement cycle does on the service component, given the 1-year service warranty that all these instruments are replaced with. So I guess, how should we think about the push-pull here we're assuming that replacements will be a growth vector in LSD and AMG, is it going to be a growth detractor in ACG? Kind of how should we think about that? .