Agilent Technologies, Inc. (A) Goldman Sachs Healthcare CEOs Unscripted Conference Transcript

Agilent Technologies, Inc. (NYSE:A) Goldman Sachs Healthcare CEOs Unscripted Conference January 5, 2022 2:05 PM ET

Company Participants

Mike McMullen – Chief Executive Officer

Bob McMahon – Chief Financial Officer

Conference Call Participants

Matt Sykes – Goldman Sachs

Matt Sykes

All right. Good afternoon, everyone. I’m Matt Sykes, the Life Sciences Tools and Diagnostics analyst at Goldman Sachs. And today, we have the pleasure of kicking off the new year with Agilent, Mike McMullen, CEO; and Bob McMahon, CFO. Mike, Bob, thanks for joining us today.

Bob McMahon

Thanks, Matt.

Mike McMullen

Thanks, Matt. Happy New Year to you and to your clients and I must say it’s great to be here in a face-to-face environment again.

Matt Sykes

Certainly is. It certainly is. Maybe we’ll start off just kind of – I’ll let you guys set the stage a little bit and talk about the most recent quarter you had, your fiscal fourth quarter and some of the trends you’re seeing across your businesses, particularly how you ended the year just given the way your fiscal year shapes up would be, I think, interesting know and kind of how you see 2023 shaping up?

Mike McMullen

Yes. No, the timing of how this conversation is just great coming off a great close to 2022. And if you look at our performance, 2021 was a great year for the company, and then we topped it off with even stronger year, the following year with double-digit growth, 12% core, margins up 160 basis points earnings per share of 20%. I’d like to say that because there’s momentum in the business and we felt really good about the – how the team has continued to deliver for our shareholders and our customers, and we’ve probably exited the year with good momentum.

Obviously, there’s question marks about the long-term outlook for the economy in 2023, but we felt like we had a reasonable look, particularly at the first half of 2023 because of the strength of our backlog. And you may recall some of our conversations, Matt, where we’re really kind of really keeping an eye on how would the order picture look like for the rest of the calendar year because we mentioned later we’ve got this October 31 fiscal, but we’re also keeping an eye on how we finish the calendar year business and is as expected. So that gave us a real sense of confidence that we had kind of a good bead on what was happening in the marketplace.

Matt Sykes

Great. Maybe we dig into the guide a little bit. I mean, if we look at what your kind of guide implies for the full year relative to what you guided for Q1, it seems very front-end loaded guide for the year so implying a slowdown in the back half of the year. Clearly, there’s a lot of unknowns about the back half of the year. Would love to kind of get your view as to the level of Agilent prudence in the back half versus things that you’re actually seeing in the market based on conversation…

Mike McMullen

Bob I think that is going to stick with us.

Bob McMahon

Stick with us exactly.

Mike McMullen

So Bob and I are a tag team on this and I think there’s a high level of prudence in the guide because of the uncertainty. Not many things that we know, but what we know is that the – we’ve got the strength in – of business we can expect from the backlog, we’ve got the on-target year-end orders, we’ve got a very resilient services business, we’ve got some reservoir things, great things happen in our NASD business. So we have a lot of confidence about the first couple of quarters. There’s just a lot of uncertainty about the back half of the year. I think what you’re thinking, Bob, is we…

Bob McMahon

Yes, absolutely. We came into this year as Mike, you just mentioned, with strong momentum. Actually, Q4 was our strongest quarter within the fiscal year, we ended with elevated backlog. So we have really good visibility into the first half of the year, and we’ll see how things play out in the second half of the year. We’re going to go up against tough – tougher comps, which plays into that, but I think it is an element of that prudence. And we’ll know more in a few quarters.

Mike McMullen

Yes. And I think under the guide that we will know more, I think we’ve got indications from our large customers that they are planning to have increases in their budgets.

Bob McMahon

Budgets, yes.

Mike McMullen

We just don’t know what they have actually settled out to and it probably will be a couple of months before we know for sure.

Matt Sykes

Got it. Maybe there’s been a lot of discussion around instrument growth over the past year. 2022 and 2021 were exceptional years for instruments. So if I look at your commentary on the Q4 call about your backlog and then your guidance for mid-single digits for instruments growth for the full year, that again, implies a high visibility and strong first half with an uncertain back half. But maybe talk a little bit about things that you’re seeing within the instrument market, maybe break it down. I know we talked before about small mall versus large mall and kind of what you’re seeing in the instrument market to kind of give people a little bit more clarity as to how to think about the full year?

Mike McMullen

Sure. Sure, Matt. And when we talk about uncertainty, really, it was uncertainty around CapEx purchases, right, instrument purchases. And when you look at the two largest markets for Agilent Pharma and our chemical and advanced materials market, what we’re looking at is how long can this accelerated replacement cycle for liquid chromatography in small molecule pharma continue. So listen, we’ve enjoyed the growth rates of – 20% to 30% growth rates in liquid chromatography over the last two years. I just don’t think there’s been a structural change in the market. So we think we’re kind of in, if you will, baseball terminologies, or maybe we’re talking about football during the fourth quarter here going down for the two-minute drive. So, we would expect a moderation of growth in small molecule replacement. It’s hard to say when that’s going to happen. But we’re kind of assuming, if you will, in our guide that some of it will be in the second half of next year.

At the same point in time, there is also other positive puts that we haven’t seen actually in my career. You are seeing new secular drivers in the Advanced Materials space, which as you may know is roughly a third of our CAM space, about 30%, 35% of our business. We think that’s growing 10% double digit growth rates, onshoring of critical components, investments in semicon and then whole revolution that’s going on in automobile industry with battery technology for electric cars. So we think there’s some – and then the other one we’ve been talking a lot about today, Bob, has been the PFAS market. So while there are some kind of maybe a potential of slowing of demand in liquid chromatography in the small molecule, we will see continued strength in biopharma side of that market. But we’re also seeing new drivers of growth in chromatography both LC and GC in these other areas.

Bob McMahon

Yes. And I think it’s important to add on the small molecule side, our view is that it’s going to revert to the mean.

Mike McMullen

Yes.

Bob McMahon

So it’s still growing. As we think about how we were building the guide for FY’23, we still expect very solid growth in our pharma end market which represents about a little over a third of the business, 35% of our overall, two-thirds of that or 40% of that’s large molecule, which we expect to grow high single digit to double digit growth. And the 60%, which is the small molecule element, still expecting to see mid-single-digit growth there. So, still very good growth but not at that 20% level.

Mike McMullen

Yes. And our commentary shouldn’t be interpreted of any concerns on the competitive nature relative to our portfolio. In fact, we know via the objective inventory stats, we’ve been continuing to gain market share in core liquid chromatography. So it’s more about, based on what we’ve seen historically in these markets, they will be virtually mean over time.

Matt Sykes

Got it. And maybe one more on instruments. We often get the question of sort of replacement versus sort of Greenfield demand. And I think some of that has to do with the end markets. Because you think about some of the areas in advanced materials within CAM, there is actually some of the greenfield opportunities, whether it’s PFAS or lithium batteries, et cetera. But maybe kind of help us understand maybe the split over the past few years in terms of replacement versus greenfield and where you could see that over the course of 2023 changing, if at all?

Mike McMullen

I think Bob may be we want to think about this as we kind of take it by end mark. If you go let’s say let’s go pharma first. I’d say it’s probably 60-40 kind of reflective of the mix between small molecule and large molecule. So the 60% being more of a replacement side of the market and about 40% is new demand. And even in small molecule China is expanding their territory. It’s more of commentary around U.S. and Europe.

Bob McMahon

Yes. And I would say in terms of the Chemical and Advanced Materials that has historically been a replacement market.

Mike McMullen

Yes.

Bob McMahon

But some of these new secular areas such as reshoring and some of these newer technologies such as the research behind lithium batteries, the semiconductor, that’s all greenfield. And so what we’re seeing is I would expect to see more greenfield in 2023 and 2024 than what we actually saw in 2022. And I actually think that that’s a positive because there will continue to be a refresh of the existing business. But in both of those categories, it’s not replacing existing capacity, it’s adding to the overall capacity. And I think in those areas we gain more than our fair share of the existing market share.

Mike McMullen

Yes. Bob is making a very important distinction here, which was historically, I think, people have thought or that space as almost all replacement business, and it’s not the case at all anymore. And like I said, there’s some nice new growth drivers for us on the secular side.

Matt Sykes

Got it. We’ll get into that in a little bit. Maybe just shifting a little bit, Bob, just on operating margin expansion, we read our strategy reports, some or the strategy reports, which are basically going for a challenging year overall for the market for margin expansion. How are you viewing your margin expansion opportunities in 2023? And how important is continued high growth in instruments that margin expansion strategy?

Bob McMahon

Certainly, growth cures all. But I think we’ve demonstrated both in very high growth as well as moderate growth or even low growth, we’ve been able to expand margins. And so it is important, but we’re not reliant on instrument growth to drive our overall business. And if you look at what we did just in 2022 as an example, a lot of our operating margin leverage was actually an operating expense, which goes across. And so the investments we’ve been making in the digital applications, how we go to customer and how we support customers, I think, will continue to be a lever for us. In the instrument side this last year, we were dealing with higher input costs with chips and other raw materials and so forth.

And we were being able to offset some of that, recovering that through cost but you look at our overall gross margin, it didn’t change that much. And so I think next year, I would expect it to be in similar kind of fashion. I do think that gross margin, if you look at it, X mix, will probably be a little better this year than it was next year just because of some of the reduction in some of the pricing or cost pressures. Now, as our business in ACG grows faster, that pushes down that mix. But if you look at it on a group by group, I think you’ll actually see some improvement there.

But I still think that our ability to leverage the one adjuvant kind of culture that we have and the digital efforts will drive the majority of it in the operating expense.

Matt Sykes

Got it. In related to this, can we talk a little bit about price? I mean, last year was a pretty exceptional year across the sector. In terms of price, when you did about 400 basis points last year, you’re looking for another 300 basis points this year. Talk about sort of the customer environment today to price increases and then obviously, it’s impossible to model, but the impact of lower levels of inflation moving through the year with the level of price that you expect this year and what that impact could actually have on margins going forward.

Mike McMullen

While it’s never an easy conversation to have with customers about, we need to move on, on price, they’ve been understanding the support of the changes. They understand what’s been happening relative to supply chain costs, labor costs and such. I think as inflation starts to moderate, which hopefully is what we’re some of the additional data we’re seeing actually holds, I think they’re going to be less accepting to have multiple increases in a particular year. So in fact, we’re not assuming that in our guide now, that also assumes that there is a moderation of inflation. So I think right now the environment is still supportive, but I think you’re not going to be able to play out at least from my view, 2023 like you played out 2022.

Matt Sykes

Okay and you actually have, in that backlog though, you do have prices…

Mike McMullen

Yes. Yes. We haven’t seen it all yet.

Matt Sykes

There’s still some price realization to come through based on prior actions?

Bob McMahon

That’s correct. Yes. I mean, in 2022 we had to take in order to cover some of the increased costs that we saw, which were higher than at the beginning of the year, we had, we took multiple price increases. What we’re seeing right now is a plan to have our annual price increase, just the one, and as you say, we still have in our order backlog, the pricing increases. And so we still see some of that kind of anniversary itself into 2023.

Mike McMullen

And we’ve seen as you know, we talked a bit about, Bob mentioned ACG in terms of which is our service business in terms of how it has a different structural model in terms of gross margin. But overall, healthy profitability. This is also our customers understand that in a very labor intensive market, they understand because they’re dealing with our own labor force. So they understand and they’re accepting of change there. You just have to be viewed as doing what’s reasonable.

And we’ve gone out, as Bob mentioned earlier, his comments, we didn’t try to recover all of our costs. Yeah. So and I think we believe that’s going to serve us well in terms of our long-term relationships with customers because we never wanted to be viewed as taking advantage of the situation, particularly in a period of time when there everybody was desperate to get product and such, we didn’t want to play that game.

Matt Sykes

Yes. I think there’s sometimes in confusion is that price X should lead to operating leverage, but if you’re simply covering your costs, it flatterers the top line but doesn’t help the operating.

Mike McMullen

Exactly.

Matt Sykes

Doesn’t really give you the operating leverage. However, if inflation were to come down meaningfully over the course of this year, then the operating leverage kicks in. I don’t think that’s something that you would bake in because it’s based on inflation forecast, it’s highly uncertain. But that still could be an upside for margins by the end of this year, depending on that.

Mike McMullen

That’s right. That’s right. That’s a right way to think about it.

Matt Sykes

Some of the recent change has seen in terms of commodity prices coming down are incrementally positive developments plus currency?

Mike McMullen

Yes. And as we mentioned earlier, the currency headwinds aren’t as severe as we had anticipated.

Matt Sykes

Got it. So you mentioned ACG as you know…

Mike McMullen

As you know – as you have a dine even talk about that.

Matt Sykes

I’m a big fan of the business. I still think it’s a significantly underestimated part of the business and what you guys do. Just leveraging your large installed base, developing deep relationships with customers and actually getting competitive intelligence within the market.

So you’ve had really durable growth margin expansion. Could you maybe talk a little bit about what some of the drivers are over the next few – over the longer-term to continue that growth over time and that margin expansion for ACG?

Mike McMullen

Yes. So that was a – and I appreciate the support, Matt. I mean, that was a big strategic bet we made back in 2015 to go after a big time the services marketplace. And where we redefined in our own minds what was the addressable market and why we were doing, why we wanted to be at this business because as it historically have been sort of all about the box.

And if you look from a customer experience standpoint, that service experience was crucial to them. And we thought that we could really do a good job in there. And we also are anticipating this really gets to the root of your question of why we think this is durable is the market continues to expand.

So this is not simply me trying to take a service share gain from somebody else. We are growing share in an expanding market. So what’s going on here? So first of all, starting with pharma, and I think you’ll start to see it in other end markets as well is they really want to make sure their teams are being as productive as possible, offloading to – they want to outsource to a company like Agilent, things that their technical teams were doing, like asset management, support help, all these kind of things.

So the market itself is expanding and also the nature of what customers define as services is expanding as well. The whole area of digital service is now a new business for us. Our customers know a tremendous amount about the scientific data that’s coming off their instrumentation. Sometimes the operational data is not always clear. And they did have it, it was kind of in a very fragmented way.

So we’re now able through sort of digital services, be able to show the customers, hey, back to the competitive intelligence. Well, here’s what’s going on in the entirety of your lab and labs. Here’s the instruments, the uptime, the main thing in history, the age of the equipment, a lot of operational data that was missing. So this is a whole new set of services as well. And then I think we’re doing really well on the share side as well.

I think this market – this overall service business has lot of legs still in front of us. And we’ve had a series of strategies where we’ve been driving, what we call, connect rates. And I think we’re in a really unique position here to be the undisputed leader here because of the fact that we have the most instrumentation placed in the marketplace already.

So if you go to the labs, everybody’s got equipment from Agilent. And so we already had a relationship with customers, and now we’re just taking more of other operations under our leadership. So we’re really excited about the business. You saw, I think another double-digit growth from ACG in 2022.

The business is durable. It’s competitive intelligence. It also leads to ultimately more on the instrument side. So there’s – I think there’s lots of legs here. And Bob, I’ve been chatting about this all day. I’m sure I left something out.

Bob McMahon

No, no, no, I think you’re right. I mean, the only thing I would add is we firmly believe there’s a lot more runway in this business. When we think about that attach rate, we just crossed over the 30% attach rate in Q4, a milestone, but we’re clearly not done yet.

We think that we usually can get into the 40% and 50% – up to 50% depending on technology over time. And so this has been a strategy that’s paying off and if you think about the number of instruments that we’ve placed over the last two years, it’s been fantastic.

Those are coming off of warranty and now it’s a big opportunity for us to increase that service attach. And I think is – Mike, the only thing I would add is we see this continuing because the instruments continue to be more sophisticated. The more sophisticated the instrument, the harder it is to self-maintain and you couple that with the drive to productivity for scientists and researchers.

They don’t want the researchers to be calibrating instruments. They want them to be running experiments. And so I see this as a continuation and really has the opportunity to go across all of our end markets over time.

Mike McMullen

And as we were talking earlier today, Matt, in terms of the use of digital capabilities to provide support to your customers, pre-COVID, we were kind of pushing some of the concepts on to customers and now it’s been a pool. So to be able to support a customer remotely through digital because often sometimes, maybe as much as one-third of your service interaction on, what they call, no park calls, which are the customer is not sure exactly how – having some questions about how to operate the instrument, for example. So the fact that we can do things digitally, they love it because, A, uptime is a critical importance to the laboratory operation and even today, the customers really don’t want a lot of people shapes and around the laboratory. So a, that gives advantage to Agilent. One is we can support them digitally but if we do need to go to the customer lab, we can take care of the entire lab. So you don’t have multiple people coming either.

Bob McMahon

Yes. I think maybe just one last thing on this because that’s intangible, but I think extremely important because this is a strong competitive advantage for us. And so having a trusted adviser that – when you know when you call, let’s say, an instrument goes down and you can go and fix that instrument, that’s a very sticky business. Think about – I’d like to think about it as a mechanic or a plumber. If you have a plumber or a mechanic that you can – you’ll take your car to each and every time something needs to be done, that’s hard to displace and so the more instruments we have under contract, I think the better it is and the more sticky that customer is and actually it creates opportunities not only to improve our products but also get more competitive wins because you use them as benchmarks for the next customer and so forth. So I think it’s a real competitive advantage for us.

Matt Sykes

Got it. You kind of addressed already some of my questions on the growth side. But on the margin side for ACG specifically, it did about 25.5% EBIT margins in fiscal 2022. We’ve always thought about this business as sort of a long-term potential like a 30% EBIT margin business. Maybe help us understand sort of the drivers behind further operating margin expansion as it relates to ACG. Is 30% a realistic target? And is it attach rates? Is it geographic expansion? Like what are some of the drivers of – for ACG margins specifically?

Bob McMahon

Do you want to take that, Mike? Yes, yes. So I think – bottom line, I still think that 30% is achievable. And I think it’s a combination of a couple of things. The attach rate will really drive that. So you think about its attach rate and digital capabilities. And so if you think about attach rates, the more you have attach rates, what’s the number one cost or the number one expense and unscheduled service call, somebody who has to go out to a system. But if you have predictive capabilities to understand or you are able to actually service more instruments with that service call, you get tremendous scale.

And then I think – so the more instruments we have under contract, the more scale you’re going to have to be because you don’t have to add more people. And then you couple that with the digital capabilities. Mike talked about this, the more you can actually solve without having somebody go out and get our customers comfortable with chatting with somebody online, one of the benefits that we saw in – during COVID was because you couldn’t travel. Sometimes these folks are doing highly technical experiments that you have to get a specialist that may not be in the territory. So what they ended up doing post – pre-COVID was they’d fly, take two days.

Now you can put them on a Zoom call, instantaneous help supporting the customer. That helps, the customer increased it, but it also helps us from a cost perspective. So I think continuing to invest in these digital tools, WeChat is a great example of that in China. And then just building up the scale through the attach rate is going to help us drive that capability or that scale.

Matt Sykes

Got it. Maybe pivoting to two kind of exciting areas of your business, ASD and cell analysis, they’ve been key growth drivers for you, and now they’re getting some scale as well. Maybe talk a little bit about NASD first. When you think about sort of the move from preclinical to commercial and the boost in volumes, and you guys have been building capacity and that’s been the only constraint. It hasn’t initially been demand. But as you think about scale and the need to provide that scale at commercial – for commercial capabilities, how are you thinking about sort of your overall bioproduction, biopharma NASD type business when you think about sort of expanding outside of siRNA and other areas? And how can Agilent play a role and how important scale will be into that?

Mike McMullen

Great questions. And just for the audience, when we use the word NASD, we’re talking about our GMP-grade oligonucleotide business. And right now, we are the leader in siRNA and all the oligo drugs on a market that used in siRNA are being supported by Agilent. So – and you’re right, it’s been mainly a capacity constraint. But as we continue to build out capacity, we’ve got another production line coming online later this year. We can talk more about that. That business, I think, crossed over $300 million or so last year and we’re going to be bringing on another 150 or so of capacity. We don’t see a lot in 2023.

But we also have really special capabilities around GMP-grade guides for CRISPRs were really capacity constrained. So I think we think there’s opportunities for us to not only continue to meet the increasing demand for siRNA, but to play more broadly across that space into antisense, into GMP-grade CRISPRs. And I think there’s a real role here for Agilent play because of the reputation we have in the marketplace, which is how are we able to overtake and become number one in our space, which was not only that we have these great state of the art facilities, but we have a great technical team.

And in the way this marketplace works from our perspective, it’s not simply the customer handing over a recipe to us say, go make this. We’re actually intimately involved in their development activities. And we’ve got a reputation in the marketplace of a company that’s customer-oriented, easy to work with, highly technical and really there to ensure the customer success. So I think that’s the kind of things that get us really excited about this space because – and then the market itself is just continuing to grow.

And when we first started in this business a number of years ago, there was questions about would this science actually prove out to and we’re seeing really good indications from our pharma partners about therapeutic common market, they’re going to service even broader population – patient populations.

Bob McMahon

Yeah, I was going to say, I think that that’s where we get really excited is when we look at the targeted disease states that are being developed right now, they’re much larger targeted populations than the current products that are on market.

And I think that helps us because people, you hear about oligos production and so forth, and many people make them, but they don’t make them at scale. And so our ability to make these in kilogram scales, commercial volumes I think is best in the industry. And I think are continuing to push that envelope and invest gives us a big opportunity as the disease therapeutic areas continue to be larger and larger.

Mike McMullen

And it’s one thing to do, all it goes for research, nothing to do for GMP. And you have to have the right systems and capabilities around regulatory. And as Bob has mentioned, one of our competitive advantages is be able to produce at scale at GMP side. So we’re feeling pretty good about our position in the marketplace and we’re also feeling increasingly confident about the uptake of Train B when it would come online for us. As you may know, we had some challenges relative to COVID where a lot of the skilled tradesmen were – we just couldn’t get them, they just weren’t available because they were ill, supply chain issues that’s all behind us. So we still have work to do, but as Bob and I have been saying today, it’s under our control.

Matt Sykes

And I know this question has been asked a lot this morning in other meetings, but just kind of remind us on at a $300 million run rate as you exited your fiscal year and you’re bringing on Train B $150 million, how should we think about the phasing in of that new capacity as it relates to the run rate for 2023? And then on the cost side, how should we think about the cost side?

Bob McMahon

Yeah, that’s a good question. So, our expectation is by the end of the fiscal year we will be at kind of the capacity run rate. But I think if you thought about that $150 million run rate created a third of that, that’s probably a good number for FY2023 we’re assuming double digit growth happening and then obviously the full complement happening in 2024, so going on a $450-plus million book of business in 2024.

We are going to expect to see startup costs probably into the tune of $10 million to $15 million in 2023. That’s built into it, it’s baked into our guide probably starts in 20 – in the second quarter as we’re training, bringing on folks for training on the floor and we’ll have more of – the incrementals look very good, but you’ve got a fixed cost of turning on the light, so to speak. And then going into 2024, then you would have that run rate being very accretive to the overall company.

Matt Sykes

Got it. And then just on cell analysis business, a similar question. I mean, you’ve built this business over a series of transactions or sort of last call is seven years built it into about a $375 million business growing around 25% plus. As you think about scaling that business as well and competing in that business, how do you think about Agilent’s position today versus where it could be? And how do you think about investments both organic and inorganic?

Bob McMahon

Yeah. So thanks for that question, Matt. In fact, we’re all delighted. This is an example of our buy side of our growth strategy and through a series of really targeted acquisitions I think we build a nice business. And I think it first of all starts with the kind of view of our portfolio, right? So we have some of more traditional tools in the cell analysis, like plate readers, but we also have leading cutting edge where nobody else has these live cell analysis, for example, some of the imaging platforms. And so we think we have the scale to compete. And what we’re after and we’re going to be driving and why we’re going to continue to win is to be able to integrate these tools in common data formats to be able to have the integrated data analysis because what you would find as you go into these laboratories is they were using different equipment from different vendors, and we’re now going to have integrated workflows.

That being said, this will be an area that we could see not only increased organic investments, but there are other things we can do inorganically here as well. So that’s an area that we’ll continue to look at for opportunities.

Matt Sykes

Got it.

Mike McMullen

And I think probably the same thing holds, we didn’t – I didn’t mentioned earlier when you were talking about the NASD business, there could be inorganic plays there as well.

Matt Sykes

Got it. Just shifting a little bit to the risk side of the business, as we see them at least and would love to get your view on it, Europe is kind of still high on our list, given the energy situation over there. You’ve called it out over the last couple of quarters as being sort of on your watch list. You grew 14% in fiscal Q4 in Europe, so it hasn’t shown up yet. But it’s something that you’ve obviously talked about and is concern of – how do you see sort of in Europe the best of your ability playing out over the course of this year, particularly if we get a mild winter? Has there been some sort of subdued spending from some of the customers over there we could see return in the back half? How are you thinking about that?

Mike McMullen

Yes. No, so great question. And I mentioned earlier that we’ve now been able to see how the business finished through calendar year 2022 and haven’t seen it yet. It would be the same statement around Europe. I think – but I think we still have to be cautious there because there’s just so much macro noise around the economic impacts and the customer’s ability to invest when they’re dealing with higher energy input costs. That being said, if things do continue in terms of moderate – more mild winter, if energy prices aren’t at the escalated levels that people had anticipated, that could be that positive for us. We’re not ready to call it but if that situation would develop with this thought as we set up the company, for 2023, what we knew was pointing to slowness in Europe. We haven’t seen it yet, but those macro win headwinds that people were – have been concerned about haven’t also dissipated either.

Matt Sykes

Yes. Got it. In regards to China, obviously, some big policy changes there when it comes to COVID, which given the disruptions that you saw earlier this year, which – I have to say, you probably had the most significant disruption during calendar Q2, you still beat numbers, so it was very impressive. But – so we’re probably not going to see that from a government policy standpoint. However, there still probably will be disruptions because of COVID in China. How are you thinking about the opportunities in China under the sort of the new non-zero COVID policy? And what you’ve learned this past year in terms of how to adapt to that environment?

Mike McMullen

Yes, thank you, Matt. First of all, thanks for the recognition on how we handled 2022. I think sometimes we may get lost in a quarter-to-quarter variation was we did 18% of growth for the year in China. And then as you mentioned earlier, in our second quarter, we were pretty much for shut down in Shanghai for a large part of the quarter, all of April and a good part of March. And the team did find a way, the business was never lost, it was always deferred, et cetera. But in terms of learning, and I’ll get to the impacts of how we see the change in policy, in terms of learning what we’ve done since then is really made sure we opened up multiple entry points into the country. So what we saw was if there was a lockdown, it would be in one particular area, but we over-indexed to Shanghai.

So what we’ve done is, we’ve opened up a lot more importation routes into the country through

different ports of entry. We’ve also put more – and you probably saw us a little bit in our working capital, we put a little bit more in terms of consumables and support parts in, what we call, forward stocking locations so that you weren’t dependent on a support part coming in from the U.S. or Germany or someplace to get to our service engineers.

So that’s kind of things we’ve done to sort of mitigate the risk. We relative to the change in policy, we were really delighted to see that because it’s now the situation is more under control, we’ve actually already weathered one of those storms already without any impact. We’ve seen a lot of – we saw the wave kind of go through as a large percentage of the workforce was hit with COVID. They’re all back to work now. So fortunately, we haven’t seen high degrees of real severity of illness. And we’ve learned – back to learning, we’ve actually learned to work remotely because a lot of people were still working remotely even ahead of COVID.

So long story short, we’ve already experienced some of the waves on our workforce in 2023. You won’t hear us talk about it in the quarterly call. So we’re feeling that it’s going to be more of a, if you will, normal cadence of business in China. And then hopefully, this also leads to improvements in the overall economic growth in the country, which I think is really part of the reasons behind some of the changes. And then we’re also hearing some indications that there may be some stimulus coming the way in 2023, still early days. So there’s – I’d say right now there’s more net positives than net negatives relative to what’s happening in China.

Matt Sykes

Yes. Maybe address that stimulus because we were talking about it earlier about it could actually represent an upside for the back half of the year, particularly in the academic channel within China. Maybe talk about the dynamics of actually the stimulus money translating to spend in China relative than what people like you see in the U.S.?

Mike McMullen

Yes, no, so, sometimes it’s a little opaque in terms of what’s going on. But once the decision is made, it gets implemented very quickly. So we’re hearing indications that there’s going to be money going into particularly life science research, academic research and we think once those plans get finalized, they get implemented really quickly. On the flip side is, the CHIPS Act in the U.S. was implemented with a lot of – was announced with a lot of fanfare. It’s taken some time to actually get the point of the money being there. Now it’s the good news is we’re actually starting to have the conversation with customers about what this means for the new facility. So it’s starting to happen in the U.S., but I’d say we think from announcement to implementation in China, we can expect that to happen more quickly. So perhaps there’s a scenario that says, hey, after they come back from Lunar New Year, we know, get some more clarity and maybe it’s even as early as the second half of second half of 2023. We haven’t assumed any of that.

Matt Sykes

Yes, this is not in your guide.

Mike McMullen

No, no.

Matt Sykes

Got it. Moving to the newly renamed CAM segment. It’s obviously had a great couple of years, and you’ve talked a little bit about some of these secular drivers, semis, lithium battery material sciences, kind of how are you managing these end markets in terms of capacity, spend and focus? And do you feel that the overall CAM segment is significantly less cyclical than it has been in the past? And I do want to follow up this question with sort of overall commentary on resilience of Agilent and how the perception of Agilent is necessarily lined up with the reality of Agilent today when it comes to the resilience. And I think the CAM segment is actually a key part of understanding that.

Mike McMullen

Yes. I’m not looking at your question, but I’m so glad you asked that question because that will be part of our – continue to be part of our storyboard, which is a much more resilient company. And the CAM segment is one – and we purposely changed the name because I’ve got a support contracts business, which is roughly 10% of all of Agilent. I’ve got an energy business which is less than 2% and that’s what everybody always wants to talk about. Why are we talking about such a small piece of our business? By the way, we talked about this Chemical and Advanced Materials segment just to kind of frame it for the audience, about 35% of that is, what we call Advanced Materials, about 55% is Chemicals and about 10% is energy related.

Matt Sykes

It’s 20% of the overall business?

Mike McMullen

And 20% of the CAM – 20% of the total company; and then this Advanced Materials, we think there really is secular drivers behind it. So what are we talking about? What we’re talking about is the revolution that’s occurring in the automobile industry where we’re moving to electric vehicles, which requires batteries and there’s a lot of investments happening in terms of not only in production of batteries, but making them better. And a lot of that is centered in places like China. So – and that’s also a concern from many people’s perspective, nobody wants to have a concentration of key supply chain components anywhere in the world.

So we’re seeing both investments in China as well as in the U.S. and in particular, in this area. We talked a bit about this already. The on-shoring that’s going relative to – initially it was about key ingredients for the pharmaceutical value chain, but now it’s really focused on semiconductor chips. So we think there’s new, if you will, secular drivers in the CAM space, which makes this market less cyclical. There’s still a level of cyclicality there, but not like it was historic. And I think we’re going to, Bob and I we are going to put in together some material to kind of show this to everybody. But…

Bob McMahon

Yes. I think maybe just to put a couple of numbers to that. So the area that is probably the most cyclical is that energy set, 10%. Five years ago, that was about 30% of the overall market. So you can see in over this last period of five years, a dramatic shift. And then you couple that with more and more services being built into kind of the CAM market as well as part of ACG’s expansion and so you get this more resilient business. And I think these investments in semiconductors, reshoring and then the lithium-ion batteries, that – those are things that I think are strategic countries and industries that are not going to change in the near term. I think that we see those as secular growth drivers that are going to be able to power through maybe some short-term kind of changes in the macro.

Mike McMullen

And I think this is an unappreciated part of Agilent’s business as well, which is having the strength in the applied markets is a net positive, right? Because I’m investing in core technology, say, for the pharmaceutical industry, but I can use those technologies in the same end markets as well. And we have a legacy of leadership in the space. Customers know us well. We’re well established. So it’s a nice leverage play for us as well. And then while it’s not in the CAM space, we’re also, as we were talking a bit today, the whole PFAS testing is a new – but PFAS testing is also a new secular driver for the business we haven’t seen for some time.

Matt Sykes

Yes. I mean, PFAS was funny when we initiated on the sector in 2020, we wrote about PFAS and no one wanted to talk about it. And so it was just crickets. But I think it’s – you guys were probably the first one to really start talking about PFAS. And I think the technology has now come to the point where it’s implementable and the problem, given some of the new regulations that are coming in and will be coming, I think the problem is being recognized. So maybe help us frame the size of the market today, the growth rate, what your share of that market is today? And how do you see this playing out over the next couple of years in terms of future regulatory EPA getting involved? How do you think about it?

Mike McMullen

Yes, I think the audience is probably already quite familiar with the word PFAS, but again we’re talking about the forever chemicals, and you may have seen some recent announcements of large companies getting out of the space because it’s very clear that there are some issues relative to health consequences. There’s thousands of these. We’re seeing indications that there’s going to be certain – certain chemicals will be regulated. And we think this is early days. I think perhaps the reason why we’re talking about it is we’re the leader in the space.

So we sized the market of roughly $200 million, we’re probably half of that right now. We think that this has got multiple years of double-digit growth ahead of us because it’s going to be a regulatory-driven marketplace. The regs themselves are still evolving. A lot of it is now state-by-state here in the U.S. But you could see eventually perhaps something happening at the U.S. national level, the EPA I think you’ll see regs happen in EU as well as China.

So and I think there’s going to be continued focus on the research because it’s still not clear exactly what – it’s everywhere. And how concerned should we be about all of them or is this a subset of them. So I think there’s going to be money in the research.

Bob McMahon

So we’ve really started seeing kind of kickstart with the Infrastructure Act here in the U.S. And speaking of time, it took to get money from an act actually down to companies and states and so forth. And I think that that’s where we’re starting to see that state-by-state regulation. But I think now what you’re seeing is potential for EPA to have standards across water testing in some areas. And I think that, that is – would be a real growth driver in terms of just the volume of screening that would be required. And as you said, the technology continues to advance and the science continues to advance in terms of understanding what these potentially could mean.

Mike McMullen

And we think this is an expansionary play because to do this properly, you need to have the latest technologies. And we also know that our customers in environment labs, they don’t have unused equipment to begin with. So it’s not a matter of just running another application on the existing equipment. So we see this as incremental growth.

Matt Sykes

And for the, on this is a mass spec plus services around mass spec type?

Mike McMullen

Yes. And our claim to fame here is not only to have the great instrumentations required, but the integrated workflow, including the sample prep to be able to, if you will, soup to nuts, be able to work with a customer and how to do the application.

Matt Sykes

Okay. And minute left, we’re going to touch on capital deployment. You’ve already talked a little bit about it. But I think what would be interesting to folks is sort of the sense you’re getting from sellers has that – has sort of the bid-ask spread narrowed and how are you thinking about private versus public, bolt-on versus larger, just your view…

Mike McMullen

Yes. So I think you’re talking about the M&A element of our capital deployment. We’re also, as you know, are going to be investing on the CapEx side, as we talked earlier. But as Bob mentioned, I think, earlier today, it says we’re now in the same room. We weren’t even in the same building before in terms of bid-ask spread. I’d also say that we’ve historically focused on the private sector, but there now are some interesting things that have us looking in the public space as well.

There are some companies out there that have been kind of beaten down, but maybe unjustified so. I mean, they’re still kind of – we’ve got to be really careful because some companies we don’t see viability of their businesses, but okay that might be interesting. So we’re more open to doing public deals and be, we would continue to do it on a friendly basis though. So we see the valuation as a net positive to this space. We also see HSR as real.

So if you’re still – if you’re not – if there isn’t any overlapping, it’s an easier path for you to win the deal in terms of approval standpoint. But I think you also do quality deals because money is no longer for you.

Matt Sykes

Yes. Got it. Well, with that, we will wrap it up. Mike, Bob, thank you very much, and go Eagles.

Bob McMahon

I was ready for the go birds. Come on…

Mike McMullen

Thank you, Matt. Thank you.

Question-and-Answer Session

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