Agilent Technologies, Inc. (NYSE:A) Q3 2023 Earnings Call Transcript

Agilent Technologies, Inc. (NYSE:A) Q3 2023 Earnings Call Transcript August 15, 2023

Agilent Technologies, Inc. beats earnings expectations. Reported EPS is $1.43, expectations were $1.37.

Operator: Ladies and gentlemen, welcome to the Agilent Technologies Q3 2023 Earnings Conference Call. My name is Bo and I will be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Parmeet Ahuja. Parmeet, please go ahead.

Parmeet Ahuja: Thank you, Bo, and welcome, everyone, to Agilent’s conference call for the third quarter of fiscal year 2023. With me are Mike McMullen, Agilent President and CEO; and Bob McMahon, Agilent’s Senior Vice President and CFO. Joining in the Q&A after Mike and Bob’s comments will be Jacob Thaysen, President of the Agilent Life Science and Applied Markets Group; Sam Raha, President of the Agilent Diagnostics and Genomics Group; and Padraig McDonnell, President of the Agilent CrossLab Group. This presentation is being webcast live. The news release for our third quarter financial results, investor presentation and information to supplement today’s discussion along with a recording of this webcast are available on our website at www.investor.agilent.com.

Today’s comments by Mike and Bob will refer to non-GAAP financial measures. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. Unless otherwise noted, all references to increases or decreases in financial metrics are year-over-year and references to revenue growth are on a core basis. Core revenue growth excludes the impact of currency and any acquisitions and divestitures completed within the past 12 months. Guidance is based on forecasted currency exchange rates. During this call, we will also make forward-looking statements about the financial performance of the company. These statements are subject to risks and uncertainties and are only valid as of today. The company assumes no obligation to update them.

Please look at the company’s recent SEC filings for a more complete picture of our risks and other factors. And now I’d like to turn the call over to Mike.

Mike McMullen: Thanks, Parmeet, and thanks, everyone, for joining our call. In today’s call, I’ll walk you through our Q3 results, share what we’re now seeing in the market and provide context for our revised full year outlook. I’ll then turn things over to Bob for more detail on the quarter and outlook before returning for some brief closing comments. The Agilent team continues to execute well as we navigate our way through ongoing challenges of the current market environment. Our Q3 revenue was $1.67 billion at the top end of our expectations. This is a decline of 2% on a core basis against a tough compare of 13% in Q3 of last year. We continue to be proactive and are taking steps to help us deliver on our leveraged earnings model.

Operating margins are 29.3%, up 180 basis points. Quarterly earnings per share of $1.43 are up 7% and above our expectations. The major drive behind our Q3 year-on-year decline in revenue is our China business. Excluding China, the rest of Agilent grew 2%, which was better than expected. We knew we’re up against a difficult compare in China and had previously guided for lower China revenues in Q3. However, the economy in China continued to weaken during the quarter, translated into a more challenging market environment than we had anticipated. With the softer market conditions in China and continued global macroeconomic challenges, we have lower growth expectations for the remainder of the fiscal year. We now expect core growth for the full year to be around 1%, down from our previous guide.

Based on what we’re seeing at this time, we’re not assuming any improvement in the China market for the remainder of the year. We, however, view the near-term challenges we’re experiencing as transitory and remain confident about the long-term growth prospects of our end markets. Before turning now to our third quarter results, I’d like to touch on our two largest end markets. Our total pharma business is down 8%, driven by the pharma market in China being down 30%. Within pharma, our biopharma business grew 5%, while small molecule was down 16%. The Chemical Advanced Materials market declined 3% versus a 22% increase last year. While we did see the chemical energy space being weighed down by macro concerns, slowing growth in Advanced Materials was more a function of a difficult compare as the volumes have remained steady and robust.

Looking at our performance by business unit. The Life Science and Applied Markets have delivered revenues of $927 million. This was a decline of 9% of a very tough compare of 18% growth. Last year’s growth was helped by the benefit of recovery from the Q2 2022 Shanghai shutdown. LSAG’s performance continues to be affected by the market environment in China across all end markets and pharma globally. Our sales funnel remains healthy and are up year-on-year, but deal velocity continues to slow as customers remain cautious in making capital purchases. We expect this market environment for new instrument purchases to continue for the rest of the year. At this time, we are not assuming any benefit from a year-end budget flush or incremental stimulus in China.

As we said before, we are continuing to prioritize invest in innovation. As an example, in June, Agilent’s investment innovation were on full display at the Annual ASMS Conference. The LSAG team introduced new products and comprehensive workflows to enhance data quality and productivity for our customers. These include two new LC/MS systems, a new PFAS workflow solution and an AI software for data analysis, among others. The Agilent CrossLab Group posted revenues of $396 million. This is up an impressive 11% core with growth in all regions and end markets, as customers continue to embrace our value proposition. We continue to see strong demand for our services as we help customers drive productivity in the lab. The Diagnostics and Genomics Group delivered revenues of $349 million, up 3% core.

Pathology grew high single digits as demand for our diagnostic test continues to grow. Our NASD business grew high teens. This growth was partially offset as we are continuing to see market weakness for our Genomics and Resolution Bioscience businesses. Regarding resolution Bioscience, the market for kidded NGS-based companion diagnostics has not developed as we expected. Furthermore, we don’t see a realistic path to profitability. As a result, we’ve made a difficult decision to shut down the business. However, our investments in future growth continue. For example, we achieved an important milestone during the quarter when our NASD business generated the first revenues from our Train B investment in Frederick, Colorado. Now looking forward for the company, as we navigate this challenging macroeconomic environment, we remain confident in the Agilent team and our ability to continue driving leverage earnings growth, use our agile Agilent framework.

We faced challenges before, and we’re taking actions now that will make us stronger and position us well for the future. As we stated last quarter, we are doubling down on delivering cost efficiencies and increasing productivity. The goal is to generate additional cost savings so we can continue to invest in innovative new solutions and support for our customers as we enable future profitable growth. We are on track to achieve the cost savings we’ve targeted for the second half of this year. We are in attractive markets that will produce long-term growth. Our innovation engine remains strong and the battle test at One Agilent team is driving outstanding execution. Bob and I will provide the details on our results as well as our outlook for the remainder of the year.

After Bob delivers his comments, I will be back to provide some closing remarks. And now, Bob, over to you.

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Robert McMahon: Thanks, Mike, and good afternoon, everyone. In my remarks today, I will provide some additional details on revenue in the quarter as well as take you through the income statement and other key financial metrics. I’ll then finish up with our updated guidance for the full year and our fourth quarter outlook. Unless otherwise noted, my remarks will focus on non-GAAP results. Q3 revenue was $1.67 billion, a decline of 2.3% core and down 2.7% on a reported basis. This compares with 13.2% core growth last year. Currency was a 0.5 point headwind while M&A contribution was minimal. As you may recall, Q3 of last year benefited from roughly $35 million in revenue deferred from the second quarter as we ramp back up from the Shanghai shutdown in China.

Accounting for this, our Q3 core growth would be roughly flat versus a year ago. As Mike mentioned, Pharma, our largest end market, declined 8%. This is in line with our reduced expectations coming out of Q2 with underperformance in China, offset by better performance in the rest of the world. The Chemicals and Advanced Materials market was down 3% off a very tough 22% compare, but dollar-wise was flat sequentially. The academia and government market was up 5% and with all regions showing growth except the Americas, which was flat. Our business in the diagnostics and clinical market grew 3%, driven by high single-digit growth in pathology, partially offset by genomics weakness. The environmental and forensics business grew 2%, driven by double-digit growth in the Americas and Europe.

The growth was generated by the build-out of water infrastructure projects and an expansion of funding for PFAS-related activities. The food market grew 1% based on strength in Asia outside of China and mid-single-digit growth in Europe, driven by new food testing regulations. On a geographic basis, while China underperformed, the Americas and the rest of Asia were better than expected, while Europe was in line with our expectations. Moving down the P&L. Third quarter gross margin was 56.3%, down 10 basis points from a year ago. Like last quarter, this was largely due to the product and services mix, and pricing was slightly better than our expectations. Below gross margin, the expense reduction actions we initiated in the second quarter helped strengthen operating margins.

We also benefited from a reduction in variable pay expenses. As Mike mentioned, margins were 29.3%, up 180 basis points from last year. Below the line, our interest income was higher than planned, while our tax rate was 13.75% and we had 295 million diluted shares outstanding. Putting it all together, Q3 earnings per share were $1.43, up 7% from a year ago, a very good result given declining revenue. Now let me turn to cash flow and the balance sheet. I continue to be pleased with our cash flow generation this year. Cash flow from operations was $562 million in the quarter, and is $1.3 billion year-to-date. In Q3, we invested $81 million in capital expenditures, totaling $214 million year-to-date, effectively flat year-on-year as we continue to optimize our CapEx spending.

Given the strong year-to-date results, we are increasing our free cash flow forecast for the year to $1.2 billion, comprised of operating cash flow of $1.5 billion and CapEx of $300 million. This is an increase of $250 million from the midpoint of our previous guidance. Despite the challenging macroeconomic conditions, our balanced capital allocation strategy is intact. During the quarter, we returned $401 million to shareholders. $66 million through dividends and repurchase shares worth $335 million. This ongoing balanced approach to capital deployment is another example of the confidence we have in our team and our belief in the long-term strength of our markets. Before getting into the revised full year outlook, I want to mention we have taken a $291 million pretax charge in Q3 associated with the decision to shut down the Resolution Bioscience business.

This charge, which is excluded from non-GAAP results, includes an impairment write-down along with charges associated with the wind-down and exit of the business. We expect the wind down to continue through Q4 and into early FY ’24. Now to the revised outlook for the year in Q4. Given the more challenging macroeconomic environment we are seeing, particularly in China, we now expect full year revenue to be in the range of $6.80 billion to $6.85 billion. This represents a decline of 0.7% to flat on a reported basis and core growth of 0.8% to 1.5%. This is a core growth reduction of 260 basis points from the midpoint of our last guide. Roughly 85% of the change is related to reduced expectations in China while the remainder is due to some incremental cautiousness from our customers on CapEx spend as well as softness in genomics and the shutdown of Resolution Bioscience.

As Mike said earlier, we are not assuming any incremental stimulus in China or any material year-end budget flush in these revised projections. Given the large change in China, I wanted to provide some additional perspective on how we are forecasting the rest of the year, recognizing that the market continues to be very dynamic. To provide some context, in Q3 through June, our business in China was tracking to a mid-single-digit decline in revenue, which was in line with our expectations. However, in July, we saw a further deterioration in China, resulting in the 17% decline for the quarter. And while the Q3 decline in China was centered in pharma, which was down 30%, we did see weakness in the other end markets as well. We expect the conditions we’ve seen in July to persist in China for Q4.

In addition, we are facing our most difficult quarterly compare in China, where we grew 44% in Q4 of last year. We are now expecting Q4 to decline in the mid-30s year-on-year. For the full year, we are expecting China to decline mid-single digits versus growing mid-single digits. With the change in revenue, we now expect full year fiscal 2023 non-GAAP earnings per share to be between $5.40 and $5.43, representing leveraged earnings growth of 3% to 4% and roughly 6% to 7% growth net of currency. The change in full year guide results in Q4 revenue being in the range of $1.655 billion to $1.705 billion. This represents a decline of 8% to 10.5% on a reported basis and a decline of 9.5% to 12% on a core basis. The recovery last year in Q4 of the remaining revenue deferred from the Shanghai Q2 shutdown negatively impacts the year-on-year results by roughly 1 point.

In fourth quarter, non-GAAP earnings per share are expected to be between $1.33 and $1.36. Thanks for being on the call. And now I will turn things back over to Mike for some closing comments before taking your questions. Mike?

Mike McMullen: Thanks, Bob. While today’s macroenvironment is challenged for new instrument purchases, we remain confident in the long-term growth prospects of our end markets, the diversification of our business and in our proven ability to grow faster than the market. I’d like to share a few examples why my confidence remains intact despite near-term challenges. In Pharma, our largest end market, innovation and advance of medicines continue with new therapeutics flowing into the market. The demographic drivers of this market are on our side, a growing global population that expects access to health care and extending life expectancy to be key priorities from their governments. Our market-leading solutions are critical to innovation behind new therapeutics and ensuring the safety and quality of on-market drugs.

In the applied markets, growing PFAS testing and the electrical vehicle transition are here to stay, action in new opportunities for growth. Everyone wants to have a safer water to drink, food to eat and air to breathe and the search for and production of more sustainable materials and energy sources remains a global priority. Agilent is a diversified leader in a unique position to help our customers drive their solutions. We remain a trusted partner, our customers though they can rely on in both good and challenging times. Our combination of leading instrumentation and world-class customer support is a long-term competitive advantage. At the heart of this long-term competitive advantage is the Agilent team and the One Agilent culture. You see this reflected in a recent recognition on Glassdoor and in being named A Great Place to Work in all 27 countries and territories around the world where we qualify for certification.

We have a company mission focused on advancing the quality of life. To learn more about this, I would encourage you to review the latest addition of the ESG report that we issued last month. We have proactively managed the company through the short term, always with an eye towards our customers and in the long term. We have been proactive in managing our business to drive leveraged earnings but not at the expense of customer satisfaction and future growth. Yes, these are challenging times, but we have the team, the strategy and the right culture that would deliver long-term success. Thank you for joining us today. And now over to you, Parmeet, to lead the question-and-answer session. Parmeet?

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Q&A Session

Parmeet Ahuja: Thanks, Mike. Bo, if you could please provide instructions for the Q&A now.

Operator: Thank you, Parmeet. [Operator Instructions] We’ll go first this afternoon to Matt Sykes at Goldman Sachs.

Matt Sykes: Hi. Good afternoon. Thanks for taking my questions. I thought maybe I’d start just with China, sort of a high-level question. You guys talked about sort of the transitory impact of the current environment. You mentioned pharma. Could you kind of extend those comments to China? Do you think it’s more cyclical versus structural? Are there competitive issues that you’re facing or just your outlook on that region? Thanks.

Mike McMullen: Yes, Matt, thanks for the question. So let me start with the last part of your question. This is a macro story, not a competitive story. So market shares continue to be very, very strong. I know there’s a lot of discussion about increased local competition, but we’ve moved pretty aggressively on our made in China strategy. So we don’t see that all as a competitive issue. Transitory, the comment there is really about the fact that the China market is not going away. It’s going to be a big market for years to come. It clearly is challenged right now. And we’re not — we’re taking a sort of one quarter at a time, actually month by month. And as Bob mentioned in his comments, I think July, we actually saw the weakest performance within the quarter, and we’re still seeing weakness in the pharmaceutical industry, for example, the level of manufacturing declined pretty specifically in the month of July.

So we think the market is going to be there, but it’s going to take a while for it to get back to growth. And I guess probably the other thing to point here is – and again, I’m talking specifically around the instrument side of the China market. As you know, we have a very large, in fact, the largest installed base of instrumentation in the marketplace. So very positive on the ability to grow the aftermarket in our diagnostics business. Probably anything you add to that? Okay.

Matt Sykes: Maybe just for my follow-up, just on ACG. So a good quarter in that business. And I know you guys talked about a year or two ago about sort of a goal of 30% plus margins obviously achieved this quarter. Can you maybe talk about sort of where you see the durability of that growth is sort of high single, low double, 30%-plus margins, how we should be thinking about the business? Or were there some one-offs in the quarter that you’d want to call out to kind of measure expectations there?

Mike McMullen: Yes. We’ve consistently communicated that we think this is a high single digit, low double-digit kind of growth business for us. It’s been that way since pretty much most of my tenure as CEO, and we don’t see that changing as we go forward. Of course, there’ll be puts and takes by quarter. But we’re continuing to see good growth in our connect rates, which we’ve talked a lot about. And we’re also doing very well on winning the enterprise business as well to complement the other aspects of our portfolio offerings. I would say that the profitability was probably a little bit higher in Q3 than – but we do think that the high double-digit number you quote about is pretty manageable for that business, but not at the level we saw in Q3, right, Bob?

Robert McMahon: Yes. Matt, this is Bob. And just maybe to further what Mike is saying, when we think about the components of that business, the fastest-growing component is actually the contracted business, which is that connect rate. And it was in the mid-teens this last quarter and continues to be faster growing than the overall business. And as long as we continue to be able to drive that increased attach rate, we feel very good about that. And that comes with – with that growth comes scale and being able to leverage our team with the work that the digital initiatives that we’ve had as well. And so as Mike said, don’t book, I think it was 32% going forward because there were some variable pay true-ups. But certainly, what you’ve seen quarter in, quarter out is a nice, steady cadence of margin improvement there.