Agilent Technologies, Inc. (A) Earnings Call Transcript

Thanks everyone for joining us this morning. I'm Vijay Kumar. I cover life sciences and MedTech here at Evercore. A pleasure to have with us Agilent Technologies this morning. From the company, we have CEO, Mike McMullen; CFO, Bob McMahon. Mike and Bob, thanks for taking the time to be with us.

Thank you, Vijay. It's a real pleasure to be here, particularly in this year's warmer venue as we were talking earlier. But I think it's really great to be here. The timing is wonderful. We just finished off closing out a very challenging 2023 with better-than-expected Q4 results. As I mentioned in our earnings call, very proud of the Agilent team in terms of how they pivoted and really went after the market and we were able to deliver leveraged earnings for our shareholders but really continue to stay very close to our customers. And I think we'll probably get into it a bit today, Vijay, but also a view that we can get back to growth in 2024. So again, happy to be here with Bob.

Fantastic. I almost expected you to come out with the one Agilent T-shirt but...

That's our secret sauce.

So you did bring up Q4 came in slightly above despite China being down in the 30s, pharma is down in the mid-teens. When you think about those different buckets, pharma, China and a non-pharma, so what business came in above, which drove the, I guess, slightly better performance versus guidance?

Yes. I think obviously, China has been a big source of discussion and variability on outlook throughout the year. We saw the results come in about where we expected. So we're very pleased with that. Kind of, as we said in our call, signs of potential stabilization. But to your question, I think it was really the U.S.-based business that really drove the better. Again, the better-than-planned performance on the revenue side.

Yes, I would say China was within kind of our expectation a little better, but still down -- is down 31%. We were expecting it to be kind of down mid-30s, but the big outlier was really the performance, as Mike said, in the Americas, which performed better than we expected.

And then as you know, we had an EPS beaten and that really, I think, we're really pleased with the impact and results of some of the work we've been doing relative to the cost structure of the company as well.

Historically, I think typically, Agilent has seen as being a more conservative company, Mike. I think your comments on book-to-bill -- it's really -- I think it created some noise in the group, if you will, and everyone has their views. But I am curious, when you made those comments on book-to-bill, talk about like how the queue progressed. Like do you see month-on-month improvements or?

Yes, sure. So I'm not sure conservative is the right term for us, but what I will tell you is the call like we see it. And we do our best to be transparent to the investor community. And we thought kind of -- if I was in the investor world, I'd say, there's a lot of different noise out there but what really is going on in the marketplace. So we thought it was very important to talk about something we typically don't talk about, which is the order book. And because as Bob can attest, we have been really eating the backlog for several quarters. And we thought it was really important to highlight to the outside world that, hey, in the fourth quarter, we actually saw -- what we saw encouraging signs of potential stabilization because we had more instrument orders than we had shipments. So we built backlog and we had a book-to-bill every 1 for the first time when Bob in several quarters. I think.

Several quarters, yes. What we saw was kind of a trough in Q2. It still started with 0.9% and then sequential improvement in Q3 and Q4 was the first time. And as Mike said several quarters that it was above 1%. And we thought that, that was it's to be very clear and orders are still down year-on-year, but obviously, not down as much as revenue was. And we see that as a good sign of potential stabilization in the marketplace. And that was not just in overall instrumentation was also the same situation in China, which I know has been a topic of conversation.

And just on those trends that you mentioned have book-to-bill progress from 2Q to bottom to in a sequential step up. Maybe a little bit more color on Q4. Was in a Q4, month-on-month that things improve? Is that what is giving us a science of?

Yes. So I think one of the things is we kept an eye on was how is the flow of business throughout the quarter and the business improved each month through the quarter, albeit down, if you will, the impact was lower as we went throughout the quarter. We've actually finished fairly strongly in the month of October, which is, as you know, in Agilent thats the end of our fiscal '23. So I think you were looking at it on the growth rates each month versus the prior year and...

Yes, exactly.

And when you look at those exit rates on instrumentation orders, I'm curious -- what is your instrument revenue CAGR versus pre-pandemic levels? Like I think there's been some noise about perhaps customers or spend during the pandemic years. Is that all out of the system? Have we or be at a normalized level.

So I'll leave the actual number to Bob. I think you may have it in your notes, but while he is looking through his notes. So what I say is a couple of things. First of all, customers don't stock instruments. They don't buy instruments before they need them. What we have been seeing during the last several years is something we've talked about in prior calls is there's been an accelerated catch-up in deferred fleet upgrades, if you will, in the QA/QC environment. And I think that's been a big part of the story for Agilent and for the industry, which was we have been foreshadowing this likelihood, which was, hey, we've been seeing 20%, 25% growth rates in core small molecule. That's more of a mid-single-digit marketplace. What we had anticipated was both the steepness of the ramp, but also the steepness of the decline we've seen over the last several quarters. That being said, we know that this -- the customers will continue to want to invest over time to keep the fleet up to date, so they can support their QA/QC efforts around the production of pharmaceuticals. So again, we think that's a mid-singles. We don't think it's a double-digit decline market either in what we're experiencing right now.

And Mike mentioned this on the call a few weeks back, if you looked at our 4-year compound annual growth rate as a company. It was at 7%, which is at the high end of our long-range plan. And if you kind of double click on that and say, what was instrumentation in that? It was mid-single digits, as Mike just talked about.

And that's always been our thesis of our long-term growth outlook for Agilent, which was the core instrumentation business, which is just one -- that's a big part of the company, but not the only part of our company's business and portfolio is a mid-single-digit kind of market environment. So we're -- we think we're right there. Obviously, there's been some variation around that mean over the last several years.

And Mike, I think in the past, you've mentioned qualitatively, Agilent's order book is different versus peers. Just remind us on how you define orders because I guess that book-to-bill -- it matters for some companies. It doesn't matter for some companies. I think we're all trying to figure out like how important is that metric?

Yes. I can't speak to the order booking policies of other companies, but when we book orders, we book orders that can only be shipped within the next 6 months. So -- and so we're not -- expectation is with our acceptance policy it's going to be revenue within the next 6 months. So -- and what I also can tell you is clean orders is a really big part of what we want to do here because we don't want to have a situation where, "Oh, your salespeople have a great year to close off the year, get paid the conversation and then come November to December, you have a bunch of order cancellations. So we're very diligent about making sure these are real orders. They have all the right documentation. So I mean it's in our order book. It's a real order. We have very few cancellations. And I think that's why we have a lot of confidence about our ability to have an outlook, at least for the next quarter or so of what revenue looks like because we can count on that order book to be real.

And what have been cancellation trends, I think you've also sort of good luck even before cancellation sometimes a pause or push out of customer deliveries could be an indication of course?

Yes. So Bob, I know that's an area...

It's a great question. We watch both of those. And one, we haven't had any increase in cancellations above trend, which -- and it's extremely low or pieces that Mike just talked about. And then even kind of the second question around extended delivery dates or taking dates and delivering later. We haven't seen any pushouts of deliveries either. So that gives us confidence that people are -- that's usually kind of an early indicator that potentially they could cancel them and we haven't seen any of that as well. So the fidelity of our backlog, we feel is very strong.

Maybe just to kind of build on Bob's response and we think about kind of the longer-term outlook for the company. This really gets back to what's in the deal funnel, right? They're not yet orders, but the potential orders. And we're not seeing deals come out of the funnel either. So that would also be a precursor to a slowdown, more significant slowdown, if active deals would actually going and this being canceled and we're not seeing that. In fact, if you would go visit one of our sites in the U.S. or Europe or Asia, you'd see they're fully booked for customer demos. So Bob and I are always getting requests on a demo equipment and more lab space. So there's a lot of activity out there in the market environment but obviously not yet releasing. And listen, we don't want to get too far down in our [indiscernible] so to speak, because the market still is challenged. And we expect, at least from Agilent perspective, we expect the first half of '24 to look a lot like the second half of '23. That being said, we really wanted to communicate this -- our perspective that we're seeing signs of stabilization. And we can dig into some of the details later on where that's coming from, so that we're not anticipating a significantly worse market environment as we go into 2024.

Understood. And I did have some questions on the cadence, what the guidance is implied. But before we get there, Mike, I think you were in China recently. Just maybe on the ground sort of -- what are customers telling you and why are we seeing some dramatic?

So thanks for the opportunity to talk about the recent trip to Shanghai. As you may recall, it's a pretty regular travel to China, haven't lived in Asia for a number of years. And it has been a multiple times during my tenure CEO, but I had been there since October 2019. I made my first trip this past September. And you immediately get off the plane, they go, "Wow, this reminder of this is the sheer size of the country, the economy, the market." And lots of things going on in the streets, lots of new electric vehicles. The country is even more green. So you can see there's a lot of things that happened in the 4 years that I've been there. But I think the one content I saw or [indiscernible] I saw really was the commitment to their initiatives around the 14-, 5-year plan. We heard that directly from government officials who we met with as well as by key government customers. And despite a lot of the political tension that may be existing with the 2 countries on the ground with our customers, they really want to continue to work with companies like Agilent and specifically Agilent, we're the leader in the space. We had a number of MUO signings. But I will tell you is, though, you're going to have to compete different in the marketplace. So my view is that the life sciences market of China will still remain important to the industry in the coming years. It will return to growth. We're not calling for that return to growth in '24. We expect the market still to be down in 2024, but we do think that market will return to growth. But as we're seeing in many other countries, there's a real push towards utilization, in country sourcing. So you may be familiar with made in China 2025, we think that's a real initiative that we're really -- we think we're ahead and we're doing the right things here. We're in the process of actually incrementally investing in China, made in China, [indiscernible] for China. So the market, I think, has remained bus, customer relationships remain strong. And I have to say after 16 or 17 quarterly Zoom calls with our China team, it was just great to actually be there, can talk to them and see what's really going on. You really find out what -- how the team is feeling about the market, what have they seen in terms of macro issues. One of the things we talked about was the whole anti-corruption campaign has really been focused in the health care industry. Our teams, although it had a limited impact on our direct business because we don't have a lot of business directly in hospitals. The message basically was sort of caused a lot of people to be cautious. And by the way, Mike, a lot of that's passed us. They really have done a lot of the actions against officials who they felt weren't doing the right things. And I also would say that if I think this anticorruption effort by the government is really a long-term plus for the industry because if you ever looked at the P&L for some of the Chinese base pharma companies a lot of money is going into marketing. And maybe some -- over time, some of the money will go into R&D. And you could see that happen in the outer years. And then Agilent in particular, we have an impeccable relationship in terms of how we do business, high integrity and I think that bodes well for our ability to continue to be a leader in China. So I'm going to say it was really fun to be back after we met so many years. And things just change very rapidly in the country and kind of gave me a renewed sense of just the sheer size of the economy, the sheer size of the market. But obviously, they're working through some challenges as well.

And off of those comments, I think China down in the 30s in Q4. What was the pharma versus non-pharma? Can you give us a sense of what your exposure in China is?

Well, Bob is looking for the numbers. The 2 numbers that stick with me are -- in Q4 last year, we grew 44%. And in the Chemical & Advanced materials market, we grew 70%. So we had some really, really tough compares we have gone up against in Q4.

Yes. And if you think about that down 31%, pharma was the largest decliner was down 44%. Everything else was better than that decline of 31%. So followed by CAM, which was down 27%. But as Mike mentioned, we were up 70% the year before. And so some of this was a function of comps. Actually, if you look at sequential in China, in CAM, as an example, it actually increased Q3 to Q4 and so forth. So it really is -- it has impacted the broader market, but it's centered in pharma.

I can imagine it's really hard to follow, right, with all the significant quarter-to-quarter variations for a lot of external events such as the Shanghai shutdown and other things that we worked on last year.

And Vijay, maybe it's helpful given China is such a topical point that we can kind of walk through the cadence of how the business went in Q4 because I think it's really helpful. For one, we had a book-to-bill that was greater than one in China, which was positive. And we saw at the end of Q3, a real challenging lot. And I think in our Q3 results, we mentioned that July was down 35%. And that's kind of what we had forecasted Q4 to be. And there was all kinds of questions about why is it not going to get worse. And so if we look at it, I'll give you 2 frames. The first is year-on-year growth by month. So July or August was very similar to July. So down in the mid-30s. September was better than -- or August was better than -- August was better -- or the same as July, excuse me, I'm getting my fiscal and calendar year. September was better and then we exited October in the mid-20s decline. And that's kind of what we're forecasting for Q1, if you think about our Q1 guide. But when you look at the dollars, the dollars have been fairly consistent on a month-to-month basis in terms of revenue. And so what we're seeing is a stabilization of the dollars a book-to-bill that's greater than 1 and the improving is a function of comps as well. And so that's kind of how we're thinking about this, and we're expecting '24 to kind of mirror what Q4 '23 look like. So if you take Q4 '24, and multiply it by 4, assuming kind of a book-to-bill of kind of 1-ish, that gets you tech kind of how we're thinking about the full year. And obviously, with Q1 being lower than that, given kind of the -- some of the seasonality.

And similar to the Q4 dynamics of pharma versus non-pharma.

Same. Everything while I was talking about the business in aggregate, what you saw in, I would say, the end markets followed that same pattern, where things got progressively better on a growth rate perspective month-on-month.

Mike, I think in the past, you've made some comments about these cycles, how long they last in China. Maybe some hints about stimulus in China. Any thoughts on if we do see a stimulus, whether that's going to be meaningful for life science companies?

Yes. So maybe there's 2 questions here. So one might be -- what have we seen historically, not only in China but globally in these replacement cycle aspects of our business. And we're probably talking about the small molecule segment of pharma. And as you know, that those instrumentations that fill up, if you will, a QA/QC lab, are just crucial for the ongoing production of safe on market drugs. And what -- and there's always a replacement cycle going on in the pharma space as our customers really try to keep their fleets up-to-date and modernize because if you allow your fleet that gets to aged, you start to have issues not only in terms of the support cost, but also most importantly, your ability to have uptime in the lab. So where this is a whole heading is that we've seen these cycles before, which is now not with a degree of variation, but we've seen this cycle before 2018, 2019, customers withheld replacing their QA/QC equipment so they could put more money into biopharma R&D. And then what you saw in '21 and '22, right, was this big catch-up, which is driving growth of north of 20% for LCs. So those cycles tend to be like 18 months or so, 18 to 24 months. And when I say a cycle we start to get back -- going back to what we believe the long-term inherent growth rate of this market is, which is the kind of mid-singles. And we think we'll probably about maybe 9 months into it. So based on what we've seen in the order book and that's one of the aspects of why we think there'll be a level of modest recovery in the second half of next year. In regards to China stimulus, it's -- love to see it, but we've been pretty contrary on this view, which is we're not expecting. We didn't expect any stimulus in '23 and we're not expecting any stimulus in '24. We don't hear any rumblings about it.

To add to what Mike said, if there is, that would be upside to our...

The upside. We're not against it -- we're not against it, but we're not just hoping for it either. So there's -- and as Bob mentioned, that would be good news for us and upside to our outlook.

Fantastic. When you look at pharma, down 14%, assuming a lot of this is overlap with China, but ex China, did instrument purchases by global pharma customers increase? I'm just trying to parse out what is China versus non-China within pharma.

Yes. So if you looked at total pharma, pharma was down 14% globally in Q4. China was down much more significantly than that. But ex China, we were down 4%. So it was down year-on-year. I think what you may be referring to, which was a positive sign was if you look at biopharma or the large molecule business that actually grew 7% ex China in the quarter. And by the way, it grew both ex China and including China globally for the full year. And so what people have talked about biopharma and having challenges, it still grew 7% for the full year, inclusive of China for us.

It were down 2% globally in the total pharma business, but up 7% globally, including China for biopharma.

So -- that's the full year. Was it up in Q4?

It was ex China.

In that large molecule, is that because I think this was some noise about stocking dynamics destocking? I'm not sure if that's relevant for you guys. Like what's...

I think you stock and destock consumables, I don't think you stock instruments. I mean, I've never seen in my career or people buy instrumentation and just put it in the closet. So...

It seems reasonable to me Mike.

Well, I mean because if you're trying to manage your P&L once you get it, you start depreciating it. So -- and particularly in the biopharma space, which is often a lot of the spends are being driven by R&D, you always want to be have access to the latest technology. So I don't think you would buy something and then say, well, maybe I'll use it in a year. And this doesn't make them now. I think a different dynamic maybe on the consumable side, for example, where at 1 point in time, a lot of concerns about supply chain issues. So customers maybe buy and hold consumables so they could support their ongoing operations. But I think that thesis done to flag instrumentation.

And this spend in R&D by large molecule customers. Is that a sustainable trend? Or was that perhaps some year-end phenomena, which drove those numbers?

No. We don't believe it's a year-end phenomenon. We would have called that out if we did. I mean it has been pretty consistent throughout the course of the year. And there is always some seasonality there. But I think one of the areas of strength has been our services business in biopharma as well. And so these are higher-end instruments that typically have a higher connect rate of services. And so even if they're not purchasing new equipment at the same rate that they add they still need the service of the existing equipment. And so we're seeing a strongness or strength there. But I wouldn't -- our view is not that this was kind of a 1 quarter phenomenon or a one time phenomenon in Q4?

And I think the point that Bob makes around the services normally speaks to the growth factor. We have also lab activity. So when the service business is robust, it also says the labs are running. The labs are wanting and activity is high.

The overall guide for fiscal '24 at the corporate level is almost flattish at the midpoint. Is a pharma expected to be flattish -- if so, then is large molecule expected to be like passover any dynamics within those different pharma buckets?