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Agilent Technologies Inc. (NYSE:A)

Barclays Global Healthcare Conference

March 12, 2013 8:30 am ET

Executives

Nicolas H. Roelofs - Senior Vice President and President of The Life Sciences Group

Alicia Rodriguez

Analysts

Charles Anthony Butler - Barclays Capital, Research Division

Charles Anthony Butler - Barclays Capital, Research Division

Ready to go? Good. Good morning. Tony Butler, thank you for joining us this session. We have Alicia Rodriguez, who's Vice President and Head of Investor Relations; and with her in the center is Nick Roelofs, who's President of the Life Science Group. And today, we thought we would go through as a fireside chat and I would just, perhaps, moderate a few questions. If you do have a question, please feel free to raise your hand and we'll certainly be able to address it. And at the very end, I'm hopeful we'll have some time, we will go through a couple of audience response questions. I think it could be fun. But following the session, then, we do have a breakout in the New Yorker Sands. I believe that's across the hall. So Alicia, Nick, thanks very much for joining us.

Nicolas H. Roelofs

Thank you.

Question-and-Answer Session

Charles Anthony Butler - Barclays Capital, Research Division

First question really is around NMR. We've had some discussion around NMR lately. So you've made some decisions around the existing OEM product line. I'd love for you to discuss what you've done there and then some of the decisions that you've made with respect to bringing manufacturing then to Malaysia from the U.S. And could you just talk about how you think the NMR business will evolve over the next couple of years? It has been an area, I think you commented, that's not been profitable today. When do you think we'd get there?

Nicolas H. Roelofs

Sure, Tony. Thanks for the question. Thanks, all of you, for being here this morning. Wonderful to look out on the ocean where the sun rises, beautiful this morning. Let me see if I can answer that question. I'm going to take a minute and give you a little bit of background of how the NMR business looks to us. Our business, we think of it in sort of 3 buckets, and then under that 3 buckets, we think of NMR in 3 piles, so it's certainly a story of 3s. For us, the business has been divided into the mid-field or heart of the NMR market, I'll come to that in a second; the ultra-high field NMR market; and what we call OEM magnet. So last week in New York, we talked about the fact that we're shutting down our OEM magnet business. That business has primarily been ultra-high field human imaging magnets that we produce as research technology products for most of the main vendors. So we've sold a couple of them to NIH, but our customer base tends to be most of the main medical imaging vendors. And we produce a magnet that's called the 7 Tesla, your normal MRI that, when you go to the hospital, you get imaged in. You see there are 1.5 Tesla or a 3 Tesla, depending on where your hospital is in the world. So that business has been very unprofitable and extremely lumpy for us. It's subject to a tremendous amount of commodity pressure, significant commodity price pressure, significant portion of the cost of the product, like 80%, has to do with the commodity subcomponents. And so when niobium goes up because there's a conflict in Africa, it causes those things to tip deeply and to not profit, and they're not strategic for the other 2 pieces of the business. So what we announced in New York is that we're going to cease making these OEM specialty MRI magnets. And that's -- we've now informed all the customers. We've informed the employee base. For those of you that model off the slides we presented in New York, we will cease taking orders. We have some revenue demand because of pent-up orders that will extend about 30 months. So you will see revenue in the slide that I showed you, it wasn't explicitly pointed out, but the revenue bars goes up. That's because we'll continue to receive revenue. The operating profit on those business -- on those particular magnets is negative. And that's orders we've taken in good faith. We'll produce in good faith. But exiting that business takes a big drag out of the P&L of the NMR group. The other 2 pieces of the group, the main field or mid-range NMR, we're very active in pushing in that area. And the ultra-high field, we're actually slowing our activities there. And we're slowing our activities there because of 2 reasons. The first reason is there was a tremendous amount of stimulus money in ultra-high field. Almost all the ultra-high field NMR goes to academic centers. And there was a tremendous amount of stimulus money in the ultra-high field in '10 and '11 that caused a lot of orders to be placed. We won some of those orders. We did not win the majority of those orders. It is what it is. But the reality is that there's very little new ordering going on in the ultra-high field NMR market for the next couple of years unless a lot of clarity and change happens in government spending around the world. And so what we've decided is, since we have not demonstrated building an ultra-high field NMR, so this would be 950, 1 gigahertz, for those people who are in the NMR world. Since we haven't demonstrated building one of those, we're just not going to quote on them. They're just too technically risky, and it becomes a distraction to our business. So we're no longer quoting on those NMRs until we build prototypes and demonstrate our capabilities and push the frontier. Last comment, and I'm sorry this has been a long answer, the NMR business itself has 3 components: probes, consoles and magnets. I focused most of the comments I just made on the magnets. They're really what drives the ultra-high field, although you need an aligned probe and console set at each field strength. We are really putting a lot of R&D and have put a lot of investment in the probes and consoles. Some of that investment was moving all of that geographically to be manufactured in Penang, Malaysia, next to our large EMG site, or physically on it, where we can leverage the capabilities of our Electronic Measurement Group. Probes and consoles are fundamentally electronics. The probe is really a radio antenna, send-receive, and the console is really a spectrum analyzer and power supply. And we are world leaders in those technologies, just not implemented in the NMR. And as I said a couple of years ago, it would take us about 3 years to design those technologies in the NMR. We are releasing designs from our technology group, EMG, into the NMR group. We've already started shipping those. And that's where our focus will be for the next couple of years, while we demonstrate ultra-high field magnets internally. That was kind of a long answer to where we are with the NMR business.

Charles Anthony Butler - Barclays Capital, Research Division

Maybe I should have started with this second question first, but it's really around the competitive dynamics in the marketplace for Life Sciences. So where do you think that you've been able to take the Life Science business at Agilent in a direction from a competitive perspective? And can you talk about the competitive dynamics in the marketplace? Where do you think that your business really is excelling, and where do you think you might need to put more resources in order to grab a larger share of that market?

Nicolas H. Roelofs

Yes, so if you look at Agilent's Life Science business, it's all -- it’s been a story about taking market share. And so we've put a lot of investment in to really focus on share. Much of that investment has been in R&D. Some of that investment has been in a split channel that allows us to specialize on the Life Science applications for the customer base. We think of that market as pharmaceutical or academic. We have other customers as well. And that's where the investment's been. The growth has been very good, above market. And so our core businesses continue to grow above market. We believe that most of our businesses are taking share. We're not a major player in much except for LC, so we're #1, we believe, in LC with the chromatography instrumentation. We've climbed from nowhere to #3 in mass spectrometry, and those have been real growth drivers. The overall Life Science market is still very robust. And so we see a long-cycle growth. There is a lot of short-term pause in what's going to happen with the government spending, which drives about half of the market. But long-cycle, it's clear that people are going to invest in the Life Science tools because those tools feed diagnostics or therapeutics, and that's a great long-cycle need. Within Agilent, what you'll see is what we're happy with is our growth and the fact that we've taken market share. What we're unhappy with is the operating profit of the Life Science Group. And we were more transparent in New York and thus the NMR question, very explicitly, because within the Life Science Group, most of the businesses, because we were investing for growth, have had slightly less-than-optimal performance, but our goal is to get that group well above 20% operating profit. Almost all of the businesses in the Life Science Group are at or above 20% operating profit. Thus, our aggregate average is 19%. There's a couple of weak businesses in there -- without NMR. With NMR, we have quite a bit of drag because of the investment we've made. And so last year, our aggregate average was 15%, and that's why we became so transparent in New York, to give you visibility that we've got a lot of core products that are doing very, very well, and we've got a few products that are in repair mode. Most of those have come from acquisitions where the intent was to repair them over a cycle. And the most visible is NMR, and that's why we broke that out for you.

Charles Anthony Butler - Barclays Capital, Research Division

If I think about the LC market, as you've made reference, UPLC has been a big technological shift. What would you say the percentage is today on the UPLC and the LC market that you've been able to push? Is it principally UPLC? And moreover, how many or how much LC actually gets pushed in, either with GC or MS?

Nicolas H. Roelofs

That's actually 2 separate questions. The UHPLC transition has been a tremendous dynamic wave for the whole market. And it's, today, driving most of the growth. If you looked at the market, you'd probably see that HPLC is flat to shrinking as a market. And UHPLC is in low double-digit growth. That's sort of our view of the market. And so the aggregate market has the continued nice, secular, mid-single digit, low in the last couple of quarters, but mid over the cycle. UHPLC today -- instruments that are capable of UHPLC being sold in the market is well over 60%. So we think that UHPLC-capable instruments are dominating. Many of us manufacturers make instruments that span the range of HPLC to UHPLC, so all of our instruments that we're selling today then go up to UHPLC capability. So we no longer sell an HPLC-only instrument. So for us, it's a lot easier to say, "We're doing very well in UHPLC, by that physical fact." But it is a place where, because the UHPLC technology has been a new wave, only the really large vendors have been highly confident. And so now, most vendors have a UHPLC, but there were several years where there was only 1 vendor, not Agilent. And then in the last sort of 4 or 5 years, there's been 2 vendors, and now 3 and 4. But our market share in UHPLC is much better than our market share in HPLC -- and oh, mass specs and GC. We -- almost all of Agilent mass specs are sold with Agilent LCs. In principle, you could buy a non-Agilent LC, but very few people demand that. Many competitor mass specs, surprisingly a high number, are sold with Agilent LCs, but we're probably still the preferred LC vendor in front of mass specs. Part of that is an artifact that many of the very confident mass spec vendors didn't have an LC business. Now, of course, our #1 and #2 competitors, who are #2 and #4 in the market, have their own LC business. So that, of course, is changing the dynamic. But we, at least for our sales, sell a lot of LCs in front of mass specs. And as I said, most of our own. But the GC and LC co-sell is true at the very low end of the market. High end of the market, Agilent is the #1 player in GC. So by that artifact, Agilent receives a tremendous amount of GC business. But it's not clear that the GC pulled LC sales, or vice versa, in the high end of the market. At the low end, where there's leverage to customers bundling, there is some clarity that a GC and LC will go together.

Charles Anthony Butler - Barclays Capital, Research Division

Can we talk about geographies, maybe, and can you parse out -- just first, parse out the Life Science business by geography? And then, but more importantly, talk about your growth in emerging markets.

Nicolas H. Roelofs

Yes. Life Science, particularly today, we're still dominated by the Americas, and that's a bit of a surprise. We've seen high-single digit to low-double digit growth in the Americas for the last 6 or 7 quarters, and that was surprising to us. My expectation is that we will see Asia pass the U.S. and America's total. I actually expected it to happen this year. Given where we are right now, it probably won't. But today, we're a little under 40% in the Americas, so high 30%s. And then mid-30%s for Asia, that's the Life Science business, and then Europe is the rest. Europe has been flat and looks like it'll stay flat for us. I mean, we have some growth, but for all intents and purposes, as a percentage of our ratio, it's shrinking by the fact that the business in Europe is flat to low-single digits. The Americas is flat to minimal [ph] growth, so it will be low-single digits. Hard to tell when that inflection will occur, because we've had some nice business there. But that, therefore, means that the Asian markets and emerging countries, which are in the low-double digits, will really see a lot of growth. We in Life Science have had a great run in Agilent. Many of you know, in China, we had really, really strong double-digit growth for several years. We had about 4 quarters where our growth was mid-single digits. And so obviously, losing share mathematically, but some of that was the need to build a team. We kind of outgrew our team. And so about 1.5 years ago, we started strong. We're rebuilding the team. We're picking up momentum. We said last quarter that we had 20 -- plus-20% orders growth in China for the Life Science Group. And we think we're back at being able to hold or gain share in China.

Charles Anthony Butler - Barclays Capital, Research Division

Elephant in the room really is sequestration. Nick, could you talk about what it means to Agilent in the Life Science market? But more importantly, what do you foresee it to mean throughout the calendar year?

Nicolas H. Roelofs

Yes. Sequestration is a huge weight on the market and not an insignificant weight for Agilent's Life Science. The challenge we see right now is -- actually moved from the absolute magnitude of sequestration to the mechanical process. So what we're seeing -- and what I mean by that is, everybody has been standing on the brakes of spending in the United States, and please recall that there's a connection. The U.S. grant profunds many offshore grants. So other countries are seeing some impact of U.S. grants not being funded to match their grants. Everybody has been standing on the brakes for several quarters, probably about 3. And so the overall baseline, people are trying to run at a rate that saves 5%, 6%, 7%. We know the mechanical sequestration will be a little north of 8%. The practical reality of that 8% sequestration is much higher because they're not going to close buildings and layoff people. But the real reality right now is lack of clarity. If the academics and government agencies knew when they could spend, we would probably see more funds released even if it were a full-blown sequestration. So right now, the sequestration's starting to leak into the baseline, so the compares will be fairly easy. Another few months, we'll start to see where they hit the brakes 12 months earlier. So the real issue is getting clarity. My own opinion is, I'm becoming more pessimistic by the day. I was more optimistic that we would get some muted form of sequestration, obviously, through March 1. We're now getting more and more days into March, and I'm just hoping that we'd get this clarity for the customers even if the clarity is, yes, it will be full sequestration. Our business impact is probably a couple of percent, that kind of impact for LS. And as many of you heard in New York, we also, the company, has a pretty fair exposure to aerospace defense, which is another vector of lack of clarity more than absolute spending kinds [ph] of problems.

Charles Anthony Butler - Barclays Capital, Research Division

Correct me if I'm wrong, but again back to the analyst meeting -- and Alicia, you may want to chime in here from an overall corporate perspective. But if I'm correct, there was this notion that the second half forecast would be better than the first half. Part of that was driven by the thought that the full-blown sequestration would not -- or at least there would be some resolution out into the future. It would not necessarily be a full-blown sequestration as we see it today. Am I incorrect in that statement? And more importantly, if we go through March -- and I guess we get to the end of March and into April, does that just create additional risk to the backside of the year for all the businesses?

Alicia Rodriguez

Well, I think you're correct in that we've -- what we're saying is that the high end of the guidance did assume that the second half would get better and that it would not reach a full-blown sequestration [ph]. So that's right. As far as going through-- and Nick, you may want to add [indiscernible]. Can you hear me now? Is that better? Okay. So let me repeat what I just said. Yes, that's correct. In New York last week, we said that the high end of our guidance assumed that there would not be a full-blown sequestration, and of course the low end had varying degrees of that being much more. So Tony, that's correct. As far as going throughout the year and that becoming less and less certain about what's going to happen there, I think that would have some impact on what we thought in our guidance. But I do think that we also feel there's going to be this sort of muddle of long, kick the can down the road type of situation, and we've tried to be pretty conservative in what we had given as the guidance. And so I think we've built some of that conservatism, if you will, already into the high end of the guidance. Nick, you want to add anything to that?

Nicolas H. Roelofs

No, I think that's pretty much a statement of where we're at.

Charles Anthony Butler - Barclays Capital, Research Division

When we think about the sales force, a couple of not great quarters. How do you keep them motivated?

Nicolas H. Roelofs

Yes, good question. Our sales guys, obviously, are our front-line weapon out there. And so we've been mitigating some of the way we compensate them. We've been putting in special programs. They're aware of the overall challenges we have in the marketplace. I mean, this is a great company to work for. We have fantastic products. If you're a sales guy, you think about very rich portfolio of products, tremendous reach around the world. So as an individual sales guy, a tremendous reach within your region. A tremendous portfolio of products. And we have a lot of technical specialist layers that are behind the sales guys to support them when they go in to win a deal. We've also -- we're pretty competitive. And what I didn't say earlier, but a lot of these relocations -- we talked about NMR as a cold [ph] for money and that we're trying to plug. But obviously, when we relocate manufacturing, what we're doing is we're moving gross margin up. And in the case of the NMR business, that may be saving it. But in the case of our other businesses, we've done a lot of relocation of businesses. So between new technologies causing us to get great gross margins and relocating manufacturing causing us to get great gross margins, we can give the sales guys weaponry to go out there and not lose deals. And so we're in a great position out in the marketplace to give the sales guys tools, whether it's portfolio or pricing, to win. And that's causing a lot of continued enthusiasm in our sales force. And we're pretty transparent. We're as transparent with them as we are with you guys. And this is a political problem. The customers have lots of money, even the academic and government customers now, because they've been slowing, have lots of money to spend. They can spend at the rate they've been spending. Clearly, CapEx -- we're so heavy CapEx, that's where the brakes hit hardest in the last year. We just need clarity, and I think sales guys understand that.

Charles Anthony Butler - Barclays Capital, Research Division

And so in summary, at least from that standpoint, if there was a budget, things would...

Alicia Rodriguez

Yes.

Nicolas H. Roelofs

Yes. But tomorrow, Washington said, it's 8.5% cut across the board, done. Well, that's mechanically stupid. Then I think the guys in stores -- well, the customers would spend. We know we've got orders out there. Once I get clarity -- we've got a guy who wants to buy 2 mass specs, a real example, and is in the U.S. academic, wants to buy 2 mass specs. But if he doesn't get all the budget, he's going to buy 1. So I'm getting 0. So it's a digital phenomenon, the orders.

Charles Anthony Butler - Barclays Capital, Research Division

Perhaps one of the last questions, and then let's move to a couple of ARS question, if possible. It's really around the replacement cycle. We've got a bit of, in general, it being 4 to 5 years. Is that right or has it changed?

Nicolas H. Roelofs

With the instrument's life, in terms of the products mass spec and LC that the group makes, 4 to 5 years is the right set-up point. It protracts in weak economies. But right now, there's been some protracting of that replacement cycle. But it's counterset by the fact that there's this technology upgrade. So whether we talk about mass specs, which have technologically evolved quite a bit in the last 4 or 5 years, and you'll see more at ASMS. But whether we talk about LCs, there -- that replacement cycle is going through a dynamic where the cyclic upgrade of technology is sitting on top of the secular. And I've been talking about this for some time in LC. We're coming to the end of that, where the cyclic upgrade will offset the secular and so it'll stop doing that offset. We're right at the tail of that right now. But right now, I think we're seeing the replacement cycle protract a little. Again, even our industrial customers are wondering about the sequestration budget. The pharma guys are worried about pill price. Other industrial customers would just like clarity -- is Greece going to collapse? The French government goes into recession, what happens? Once that clears up a bit, I think we'll also see money relief in private sector. We saw that in December. December was a big pop for us in orders, which built into a fairly nice order quarter last quarter even though -- for the Life Science group, we had a nice order quarter even though Agilent had some challenges in predicting revenue.

Charles Anthony Butler - Barclays Capital, Research Division

Can we throw up a couple -- the first ARS response. And I'm going to stand so I can read them, given -- by the way, so the issue is press the number that corresponds to the selected answer. You need to do it in 6 seconds, for those that are challenged digitally. And then the first question, should we?

Yes, so of the following companies, which do you think are most likely to surprise with earnings on the upside in FY '13? First question, TMO; second, Agilent; third, Waters; fourth, Life; and fifth -- no music. What happened?

Oh, okay. So the answer -- yes, Thermo with 57%. Interesting. Second question.

Nicolas H. Roelofs

You just don't like us? You do? Okay.

Charles Anthony Butler - Barclays Capital, Research Division

So is management being too pessimistic, just right or too optimistic concerning future growth? And this is, of course, Agilent management. First question being -- first answer, too pessimistic; just right; or too optimistic?

There we go. Nick, Alicia, thank you so very much. We'll adjourn to break out in New Yorker Sands. Thanks again.

Nicolas H. Roelofs

Thank you, Tony. That's great.

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