Agilent Technologies, Inc. (A) Q1 2020 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Agilent Technologies first quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. And now, I would like to introduce you to the host for today's conference, Ankur Dhingra, Vice President of Investor Relations. Sir, please go ahead. Thanks.

Thank you Julianne. Welcome everyone to Agilent's conference call for the first quarter of fiscal year 2020. With me are Mike McMullen, Agilent's President and CEO and Bob McMahon, Agilent's Senior Vice President and CFO. Joining in the Q&A after Bob's comments will be Jacob Thaysen, President of Agilent's Life Science and Applied Markets Group and Sam Raha, President of Agilent's Diagnostics and Genomics Group. Due to certain personal engagements, Mark Doak, President of the Agilent's CrossLab Group, is unavailable to join us today. You can find the press release, investor presentation and information to supplement today's discussion on our website at 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. Revenue growth will be referred to on either reported or core basis. Core revenue growth excludes the impact of currency and the acquisitions and divestitures completed within the past 12 months. Guidance is based on exchange rates as of January 31. 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 would like to turn the call over to Mike.

Thanks Ankur and thanks everyone, for joining us on our call today. I would like to start today's call with a reminder that Mark Doak, ACG Group President, will be retiring on May 1. While Mark and his wife are currently enjoying a long planned location and is not able join us today, I would be remiss in not taking the opportunity to recognize the outstanding accomplishments Mark has made in his stellar 38-year. His track record of results speak for itself. Thank you, Mark. We have a very strong bench at Agilent and have already named Mark's successor, Padraig McDonnell. Padraig knows the business well. He has been on Mark's staff for several years and is currently running out chemistries and supplies division. Padraig and Mark are already working on transition activities as Padraig prepares to take the helm of the ACG business at the start of fiscal Q3. Our congratulations to both Mark and Padraig. And now on to the quarterly results. The Agilent team delivered a strong start to 2020. Q1 revenues are above our expectations as business grew in all regions and markets. Total revenues of $1.36 billion are up 5.7% year-over-year on a reported basis and 2.4% on a core basis. We continue to translate our topline growth into strong bottomline earnings. Our EPS of $0.81 is up 7% and is at the high-end of our guidance. Before going into business units and market details of our quarterly results, I want to speak about two specific areas that highlight how our building and buying strategy of investing in fast-growing markets continues to deliver growth and help us create a more resilient business. First, I want to talk about our most recent acquisition, BioTek. This was the first quarter with the BioTek team onboard and the business is off to a very strong start with revenue growth above our expectations. We continue to be very enthusiastic about the cell analysis space and BioTek continues the strong momentum that originally got us interested in bring them into Agilent. The BioTek leadership team was just in Santa Clara for a few days of planned meetings and they are very energized and excited about the future possibilities to make it a great business even stronger as part of the Agilent. Second, the resiliency of our business model is on full display this quarter as Agilent delivered strong growth and earnings in the face of a negative Q1 impact from the Coronavirus outbreak in China. As this has dominated headlines, let me add a few additional comments regarding the Coronavirus and its impact on Agilent. Most importantly, our thoughts go out to all those affected by the Coronavirus. On the Agilent front, our team fortunately has not had any direct health impact and many returned to work last week. We are remotely supporting our customers as a number of them gradually resume operations. We have also restarted our in-country production activities and they are shipping products to customers within China and internationally, albeit at a reduced rate. On the business side, given that our first quarter ended January 31, we are seeing business impact across both fiscal quarters, Q1 and Q2. In Q1, our revenues are running ahead of expectations right up to Lunar New Year Holiday. However, the extensive Lunar New Year Holiday affects our customers' ability to transact and accept shipments during the last days of the quarter. This reduced our reported revenue by approximately $10 million in total for the quarter, primarily in our LSAG instrument business. We have since recognized the bulk of this revenue now in Q2. Looking ahead, we are projecting that Coronavirus will continue to impact our China business throughout Q2. Bob will share additional details, but we are anticipating delays in new equipment purchases and a slower uptake of consumables and services. The slower uptake is due to reduced number of selling days resulting from the extension of Lunar New Year, along with customer and logistics operations that are ramping, but not yet fully operational. It's important to note, while we are forecasting the impact to our Q2 business, our full year outlook for total Agilent revenues and EPS remains unchanged. Our business outside of China remains on a solid footing and we believe a large portion of our China business that is currently being impacted by the Coronavirus is not lost but rather is delayed. As you know, the Coronavirus outbreak is unfortunately impacting the health and safety of tens of thousands of people. I am very proud of how the Agilent team has responded to do our part to help. Our Agilent China team is now actually supporting those customers during crucial research into the virus. We have donated instruments and supplies to four clinical and research institutions based in China to support these research and drug development efforts. We continue to closely monitor events in China and are prepared to act quickly to help wherever possible. Now on to additional details of our quarterly results. Agilent's growth is broad-based as our business grew across all regions and end markets. Regional performance was led by the Americas posting 5% core growth with America coming in with low single digit results and Asia holding steady. Despite the timing of the Lunar New Year and the Coronavirus impact late in the quarter, our China business grew low single digits. While all end markets grew, our results were led by strong growth in the biopharma and environmental forensics markets. Now taking a closer look at how the individual business units performed. LSAG revenues grew 5% on a reported basis driven my strong performance in our biopharma and cell analysis business. On a core basis, LSAG's revenues were down 2% against a tough compare and inclusive of the unexpected Q1 impact from the Coronavirus. With the exception of China, all regions and end markets performed in line with expectations. The ACG business continues to deliver strong results, posting 7% core growth even with reduced selling days in China. This growth was broad-based across all major market segments and regions. These results continue to demonstrate the strength of our ACG CrossLab strategy and how we are leading the transformation of the analytical lab. DGG has also posted 7% growth in the quarter against a difficult 12% growth compare. We have experienced a continuation of positive trends winning share on our core pathology business and seeing strength our NGS QA/QC franchise. We continue to be pleased with the revenue ramp at our new oligo manufacturing facility in Frederick, Colorado. In addition to driving strong finance results, I want to highlight some other notable events that took place during the quarter. We continue to bring different and new product to the market, meaning strong customer and external recognition. We just introduced the Agilent SureSelect XT HS2 DNA kit. This, along with our recently launched automated sample prep platform, Magnis, further strengthens our leadership position in the NGS sample prep market. In addition, two industry publication honored the Agilent InfinityLab LC/MSD iQ system with 2019 innovation awards. The award-winning mass spectrometer introduced last June incorporates intelligent design and innovations such as embedded sensors that monitor instrument health. And finally, earlier this month, Barron's name Agilent number one in the list of the 2019 Most Sustainable Companies in America. We are very proud of this recognition. Sustainability is a critical topic that is gaining increased interest from customers, employees and investors. More importantly, we believe focusing on sustainability is simply the right thing to do. Before I pass the call on to Bob, I would like to close with a reminder of Agilent's resilience and our shareholder value creation model, delivering above market growth, expanding operating margins and a balanced deployment of capital. We are able to thrive by focusing on platforms with multiple large end markets and long term growth opportunities. We are also driving growth in the aftermarket, increasing our focus on faster growing end markets, streamlining our infrastructure and operations and investing in the future of Agilent, both organically and inorganically. We do all this while maintaining acute focus on delivering EPS growth with superior quality of earnings and driving shareholder value creation. Despite the temporary business uncertainty created by the Coronavirus in China, I remain confident about the longer term growth prospects of the China market, our China growth strategy and most importantly our team. I am very proud and confident in the strength and resiliency of our China team and their ability to overcome any near term challenges that come our way. When I look at our global team in our business, our growth prospects and team have never been stronger. We are laser focused on driving revenue and earnings growth. I am pleased to tell you that all these facts allow us to maintain our growth and earnings outlook for the year. Thank you for being on the call and I look forward to answering your questions. I will now hand off the call to Bob. Bob?

Thank you Mike and good afternoon everyone. In my remarks today, I will provide some additional detail on revenue, walk through the first quarter income statement and some other key financial metrics and then finish up with our updated guidance for Q2 and the full year. Unless otherwise noted, my remarks will focus on non-GAAP results. Our first quarter results were very good as we had strong execution across all regions and markets. Revenue for the quarter was $1.36 billion with reported revenue growth of 5.7%. Currency negatively impacted revenue by 0.4 percentage points and acquisitions added 3.7 percentage points to growth. Our core growth was 2.4% in the quarter. As Mike indicated, our performance was impacted by the extension of the Lunar New Year Holiday due to the Coronavirus. This reduced the number of shipping days in China and we estimate it shifted $10 million in revenue out of Q1. If not for the reduced shipping days in Q1, our performance would have been stronger with the shift affecting our core revenue growth by roughly 70 basis points. In terms of end markets, we saw growth across all of our six end market segments. Pharma, environmental and forensics and diagnostics and clinical led the way for us in the first quarter. During the quarter, pharma grew 3%, double digit growth in DGG and high single digit growth in ACG, offset a mid single digit decline for LSAG. Within pharma, our biopharma or large molecule segment grew high single digits. And on a geographic basis, our pharma business experienced high single-digit growth in the Americas and mid single digit growth in Europe. This was partially offset by mid single digit decline in China, largely associated with the timing of the Lunar New Year and to a lesser extent the execution of the 4+7 program. The 4+7 program is playing out as we expected with the third round completed in January and multiple winners per drug. We continue to believe that this is a long-term positive for the industry as drug quality improves and access to healthcare increases. Our environmental and forensics business grew 4% against a very tough compare last year of 10%. During the quarter, we saw balanced growth between instruments and aftermarket sales. And diagnostics and clinical revenue grew 3% against a strong 11% compare last year. Mid single digit growth in DGG, driven by continued share gains in our pathology business, were partially offset by declines in LSAG and ACG with both only having small businesses in this segment. Chemical and energy revenue grew 2%. Services and consumables grew mid single digits offset by flat instrument sales. Academia and government grew 1% with services and consumables growing mid single digits, partially offset by flat instrument sales. Mid single digit growth in the Americas was partially offset by flat to low single digit declines in the other regions. And finally, food returned a modest growth, up 1%. Low teens growth in services and consumables was partially offset by declines in instrumentation. While one quarter does not make a trend, we are pleased with the continual progress in this market. On a geographic basis, we saw growth in all regions, led by Americas growing mid single digits. Europe grew 2%, in line with our expectations. And as Mike mentioned, our business in China was running ahead of expectations through the first two months of fiscal 2020. As mentioned earlier, despite the shift of the $10 million, China still grew 1%. If not for the extension of the Lunar New Year, our core growth in China would have been solidly mid single digits. Now let's turn to the rest of the P&L. Gross margin was 55.7%, down 120 basis points versus the prior year. This is a result of the planned startup costs for our new NASD facility as well as product mix and some negative pricing effects on our instrumentation business. We offset 90 basis points as we leveraged our cost basis in operating expenses. And as a result, our operating margin was 22.9%, down slightly from 23.1% in the first quarter of last year. Adjusting for the $10 million Coronavirus impact on revenue, operating margins would have increased versus the prior year and so we feel good about our continued opportunity to expand operating margins. We were also able to lower our tax rate slightly to 15.5% and expect that rate to continue for the rest of the year. This resulted a non-GAAP EPS for the quarter coming in at $0.81, at the top end of our guidance and representing 7% growth. Before turning to second quarter guidance, I want to touch on a few other financial metrics. Our operating cash flow was an outflow of $59 million, in line with expectations as we incurred the one-time tax outflow of $226 million related to the transfer of intangibles as noted last quarter. We also paid out $56 million in dividends and purchased 726,000 shares for $60 million. We ended the quarter in a net debt position and a net leverage ratio of 0.9 times. Now let's turn to our non-GAAP financial guidance for Q2. We are anticipating revenues in the range of $1.28 billion to $1.32 billion in the second quarter. This range is larger than we have traditionally provided as we have been tempted to estimate an impact of the Coronavirus on our business in the second quarter. As this is a fluid situation, we thought it would be helpful to detail all our assumptions, particularly as we have seen impact across both Q1 and Q2. Our guidance contemplates a $25 million to $50 million impact in our first half of our fiscal year, which translates to roughly to a 1.5 to three week impact on China revenues. Of this, we saw $10 million in Q1 and we are estimating a net $15 million to $40 million incremental impact in Q2. The Q2 revenue range of $1.28 billion to $1.32 billion translates into reported growth of 3.4% to 6.6% with core growth of 1% to 4%. Currency is expected to have a negative 1.1% impact while M&A is expected to contribute 3.5% to 3.7% in the quarter. We are estimating the Coronavirus to negatively impact our Q2 core growth by one to three points. Our revenue outlook translates Q2 earnings in the range of $0.72 to $0.76 per share, 1.4% to 7% growth versus last year. Importantly, as Mike mentioned, we believe the majority of this business is not lost, rather delayed as customers and the government ramp and recover. In addition, our business outside of China remains strong. As such, we expect a larger second half of the year and are not changing our full year guidance for revenue or EPS. So before starting up the call for questions, I want to conclude by saying we have a very solid start to the year that shows the strength and breadth of our portfolio. It is that portfolio, coupled with the strength of the Agilent team that, despite the uncertainty caused by the Coronavirus, we are maintaining our full year outlook. With that, Ankur, back to you for the Q&A.

Thanks Bob. For Q&A, I would like to request to limit to one question and maybe one quick follow-up. Julianne, if you can please provide instructions for Q&A.

[Operator Instructions]. Your first question comes from Tycho Peterson from JPMorgan. Your line is open.

Hi. Thanks. I appreciate you guys quantifying the corona impact. I guess, a couple of things. I mean you have previously talked about mid single digit China expectations for the full year. So should we assume that's still the case, just more back-end loaded? And then, Mike, as we think about collateral damage within China, how should we think about the C&E market, just given that the broader economic activity in China is slowing? So should we think about some impact on C&E as well?

Sure, Tycho. I think I will handle both questions. And Bob, correct me if I go off script here. But I think we still think that the mid single digit number is doable for the year in China. What we are seeing already on ground from our team, I was just on the phone today with our team in China, we are still able to transact and orders are actually coming in as forecast. I think that we think a lot of the procurement is going to occur a little bit later in the year. We think a lot of it's recoverable with the exception of probably some aspects of our service business where customers really are looking for service people to arrive on the sites. I think we feel pretty good about how we are thinking about China throughout the rest of the year, albeit it being a very fluid situation. And you know, we really haven't seen any kind of transitory or connected impact on C&E. In fact, C&E actually did better than we were thinking in the first quarter. It's too early to call it a trend but some of the PMIs are actually inching up which would maybe give an indication of perhaps a better outlook and some initial noise in some of our major accounts about thinking on procurement. But we still remain cautious in terms of the outlook for C&E but I am f encouraged by the Q1 results. And again, we are not really seeing significant movements around in that area on a global basis. And we think back to the first comment on China, we weren't expecting a lot in C&E this year in China anyway. So I think we are in pretty solid shape relative to the outlook there as well.

And then a follow-up on biopharma. You grew 3% on a 10% comp. Last quarter, it was 7% on a 14% comp. So you know, was that a pull forward last quarter? And if so, can you maybe just talk to that dynamic?

You know, I think the big story there is China, right.

Yes. That's exactly right, Mike. There's two elements there. One is the shifting of the Lunar New Year from Q2 into Q1 as well as the extension of the Lunar New Year Holiday. So those are the two primary pieces.

Yes. And then within the pharma numbers, Tycho, the biopharma segment really was strong for us again this quarter as well. And then we think as the 4+7 initiative rolls out in the latter part of this year, then we will see the growth in the small molecule side of that space. And then, we have really strong growth in NASD and the ACG business is strong in pharma. So we are feeling pretty good about pharma.

Okay. Thank you.

Thank you Tycho.

Your next question comes from Doug Schenkel from Cowen. Your line is open.

Hi Doug.

Hi. This is Ryan, on for Doug. Thanks for taking my question.

How are you, Ryan?

Maybe just to round out the China dynamic quickly, can you provide some more color on your supply chain exposure? Within China, it sounds like the operating environment is improving. But how should we think about your direct and indirect supply chain exposure? And do you see any risk to your ability to fulfill demand within and outside of China over the course of this year?

Yes. Sure, Ryan. Thanks for that question. So as I touched briefly on my call script, we actually have resumed production and are in a really solid position now to not only ship the product to our customers in China, but also products that are manufactured in China to have them exported into the global market environment. And as we have a very diversified global footprint in terms of supply chain and manufacturing capabilities, we think the near term, we are in pretty solid shape relative to ability to meet our commitments from a he shipment perspective. And then you also may recall that starting with the initiation of the U.S. based tariffs, we actually had initiated a movement of a lot of our supply chain out of China. So it actually has mitigated our risk here as well.

Yes. Ryan, this is Bob. Just to follow-up, we have twice weekly calls with our team in China, inclusive of logistics as well as our supply chain. And obviously, it's quite dynamic but as it currently stands today, we feel like we have the ability to be able to procure not only raw materials but also produce the finished goods and ship not only within China but also get product into China and vice versa.

Great. And then maybe just following up with a brief two-parter. Number one, on the food market. It sounds like things were improving a bit prior to this Coronavirus dynamic. Can you talk a little bit more about what you are seeing in the market and if you think that the China portion of that market specifically could be poised to return to growth as we get past this Coronavirus dynamic? And then specifically for gross margin, can you talk about what the timing headwind was for the quarter versus the other dynamics that you called out? Thank you.

You want to take this, Bob.

Yes. So on food, as I mentioned, we certainly are pleased with the progress we have had several quarters of kind of very predictable performance there. And actually Q1, despite the Coronavirus, it probably had more impact on the pharma side then in food. It grew 1% on a global basis. It was down slightly in China, but certainly not to the level that it had been in the past. So we feel good about that. It's probably too early to call that it's going to return to growth. Long term, we do believe it will return to growth, but not ready to call that in this fiscal year. In terms of the timing of the Coronavirus, that $10 million, that was quite a large incremental because we had all the costs. So that was probably a higher than normal kind of incremental drop to the bottomline. And that was probably a little over $0.01 of impact on the full quarter.

Very helpful. Thank you.

Your next question comes from Jack Meehan from Barclays. Your line is open.

Hi. Good afternoon.

Good afternoon Jack.

Hi. I was hoping could you give us an update on the NASD rollout at the new site and how much that contributed to the quarter in both DGG and the pharma end market?

So as I imagine, you maybe getting a little tired of hearing this from Bob and myself. I am going to pull Sam into this conversation. But as we highlighted in the call script, the NASD business continues to ramp as we would expect. We are really pleased with the progress and how we are starting to fill out that factory. Still not yet at full capacity, operating at full capacity yet but it was a contributor to our growth in the first quarter, no doubt. And Sam, anything else you would like to add there?

No. Mike, you hit the nail the head. The business is performing as we have expected. We continue to see interest in all the customers, the pharma customers that we have given tours to. We are doing work now there for a number of customers. Not to be boring, nothing new to report. It is progressing as per plan.

So all good news right now.

Yes. I would just add, Jack. You know, as we have talked about, this will ramp up and be a more material impact in the second half of the year. It's progressing as we expected it. It had a slight impact to the DGG and a slight impact to the overall Agilent organic core growth and we are very pleased with the progress.

Yes. And Bob, I think I will just make this one more point too, while we look at the second half outlook for the business, it's not all about China recovery. The other elements of the business, including NASD, which we know we are going to have a strong second half.

That's right.

Great. One follow-up on DGG. You know, the core growth of 7%, not to nitpick it too much but was there any thing that was a little softer in the quarter in that segment, just knowing some of the other growth drivers relative to how the segment was growing last year?

I think it was really -- this is Mike, Jack and Sam feel free to jump in on this. We had 12% growth last year, so tough compares. We had solid growth across all elements of that business. And outside of again may be a China impact for an element of the business, things are firing on all cylinders also across the businesses is how I recall.

Yes. That's right, Mike. We continue to have good growth, you know, with market, above market with our overall NGS portfolio. So we feel good about that. And the low double digits, our pathology business, as you heard on Mike's opening comments and Bob's as well, we believe we will continue to gain share there growing in the mid single digits. And you just heard about NASD. So you look at the major parts of DGG, we had I think a really well-balanced good quarter.

It mainly is a comparison story.

Great. Thank you guys.

No problem.

Your next question comes from Dan Leonard from Wells Fargo. Your line is open.

Hi. Thank you. So just a couple of things to circle back to. One, what decelerated in the Americas in the quarter? Your growth rate in that region had been trending higher than 5% for quite some time.

Yes. Hi. Dan. Welcome back and appreciate the question. It was really a combination of a very tough compare. I would say probably the area that was a little softer was the instrumentation business. They had the most difficult compare in the first quarter and we would expect that to improve in Q2 through Q4 as we get to easier compares.

Yes. I know, Jacob you were looking into this.

Yes. And I think the continued depressed PMI certainly impacts C&E business, chemical and energy business. So we continue to see that in U.S. being performing at least flat and we would like to see improvement. But I think it's going to still take some time for that to happen.

And I would add that you know, it ended where we expected it to be.

Yes, sure.

And then a related question. Bob you mentioned when discussing the gross margin dynamics that there were some negative pricing effects on the instrument business. Can you elaborate on that? Are you pulling maybe the pricing lever to drive more demand in the instrument business after four quarters in a row of very soft demanded at LSAG?

Hi Dan, I just can't help but to jump in on this one. And I think that question should be posed to our competitors because we saw particularly as we finished the calendar year, we saw some very aggressive pricing by some of our competitors, particularly in the liquid chromatography and mass spectrometry platforms. And I don't know if you are adding to that, Jacob.

No. I think it's fair to say that we continue to be premium priced but there is certainly some competition in the market space right now. And yes, so there is a price pressure.

But we don't play the price game here. I mean that's not how we want to win.

Okay. I appreciate the color. Thank you.

Your next question comes from Patrick Donnelly from Citi. Your line is open.

Hi. Thanks. This is Jesse, on for Patrick. First, I just wanted to touch on the China impact. I mean you guys have laid out a 1% impact to core growth from that. I just wanted to understand how that compares to your expectations of Coronavirus made at a lower than anticipated?

Yes. Maybe just to be crystal clear here. We saw roughly a 70 basis point impact in Q1. We had product that was getting ready. It was staged and getting ready to ship.

In-country.

And on the last couple of days of January and with the extension of the formal holiday, there was no one there to pick that up. So we know that was clearly an impact in Q1. In terms of Q2, what we are expecting between the first half of our year, it's roughly 1.5 to three week impact as we are ramping up. And most of that's happening in Q2. We are expecting in Q2 that the Coronavirus has roughly a one to three point impact to our growth in Q2, roughly $15 million to $40 million. In the first half, it's $25 million to $50 million. And we will expect to get that back in the second half of our fiscal year.

Okay. That's helpful. And then just maybe one on the BioTek acquisition. Just wondering how that business performed relative to expectations and just kind of how the customer reception has been so far as you have broadened the portfolio offering there?

Yes. Jesse, happy to hit that right up. And relative to expectations, it's ahead of our expectations. It really has been just a tremendous addition to the company. And we are talking about this the other day inside the company. Typically, when you put together a deal scenario, it's often out of the gate, you don't see a team beating the revenue numbers all the time. And that is actually what we saw in the case of BioTek in the first full quarter as part of Agilent. And Jacob, I know you have been talking to customers and how are they thinking about BioTek being part of Agilent?

Yes. Again, I just want to underscore once again that we have been very pleased with the performance of BioTek while it's been here in Agilent. But not only BioTek, the whole cell analysis business is doing very well and are we posting double digit growth for the whole business. So we are very pleased with that and we actually believe it is going to continue for quite a long time. We see cell analysis is going to be a key driver for understanding the immune system and immune oncology. And with now the Seahorse, ACEA and BioTek and Luxcel combined, we have a very unique value proposition. And that that is really what excites us and what also is very exciting for customs is that when we combine those technologies, these techniques together, we can create more insight for the researchers and the biopharma customers that nobody else in the industry can do. So this is very exciting and we are just getting started.

Your next question comes from Puneet Souda from SVB Leerink. Your line is open.

Yes. Hi. Thanks Mike. So first question on Europe. You pointed 2% growth there. I was hoping to get a view from you on outlook and what you are baking in the guidance here? Thanks.

Thanks. Bob, why don't I just talk about our performance and you can maybe comment on the outlook. So it came in right as expected. And I think you know that Europe is in a difficult economic environment and we think our team is really doing well there relative to what's going on in the market environment. So we were actually quite pleased with how Q1 came out for us in Europe. And Bob in terms of the outlook?

Yes. So Puneet, good afternoon. As Mike said, we were pleased with the outlook of being 2% and that's kind of what we are forecasting in Q2 and the rest of the year. And so certainly the is doing a really great job of being able to deliver in a tough environment. But it kind of hit where we expected and that's kind of what we are expecting for the rest of the year as well.

Okay. That's very helpful. So if I could touch back on China.

Sure.

I know it's been covered quite a bit. But I would really appreciate your thought there, given one of the strongest legacy positions in that country for Agilent. As the recovery happens here, are there certain segments which you think where you will see more acceleration, more faster recovery, certain product lines or certain segments where you would see a recovery faster versus others? And then I was sort of also surprised with growth you are seeing in ACG. CrossLab continues to deliver. I was trying to understand what sort of exposure you had there in China? And given the travel restrictions and everything, are you still able to ship products and service instruments seeing the growth in CrossLab here? Or how much was the impact in CrossLab, if you could quantify? Thank you.

Puneet, let me take, there is a lot into that question. So let me try to hit them. In terms of recovery, we would expect that obviously, the instrumentation portion would recover and within that probably pharma first. And so we would expect that to be prioritized over some of the other markets. In terms of ACG, we continue to be pleased by the broad-based strength there. Actually even in China, despite kind of the reduced selling days, it grew 11%. We do expect probably a slower ramp up there, less on the consumable side as the factories are getting back to production, but more on the services side, as you can imagine having our folks getting into labs right now is fairly difficult and there is a portion of that would be on demand for servicing equipment. And so we would see that probably ramp up a little slower in Q2 but then ramp back up to normal, latter half of Q2 and into Q3 and Q4. At least, that's our current assumption. As Mike mentioned, we have been in close contact with our teams in China and have been watching the order flow. And the order flow to-date is, across both ACG and LSAG as well as our DGG business which is a smaller piece, tracking to our expectations.

Okay. And any sense in terms of the exposure that you have in China and could that mix change in the next quarter or so?

No. I don't anticipate a major shift. We have largely got a instrument heavy business in China relative to the rest of the business anyway. But our opportunity really lies in the consumables and service over time. So I don't see a dramatic change in Q2 or in the back half of the year.

Yes.

Great. Thank you.

Very welcome, Puneet.

Your next question comes from Dan Arias from Stifel. Your line is open.

Good afternoon guys. Thanks.

Hi Dan.

Mike, just back to Tycho's biopharma question. Hi Mike. Next quarter, I think the comp goes way down to low singles for that customer segment. So where are you feeling like biopharma growth heads in 2Q as we just think about the momentum in the favorable comparison, but also China? Can that be more mid singles when we net out the moving parts there?

Hi Dan. I think that's a reasonable expectation. So when I was asked earlier about the pharma, we remain confident about our ability to grow in pharma. You know, part of it's going to be the pickup and continued growth that we are going to have in our NASD business. We also know that we are getting to some of the easier compares relative to the LSAG instrument business, because as you may all recall that's in the Q2 is when we starting seeing the slowdown as China went through this whole looking at their procurement practices around the generics. So we think there is a lot of good reason to be positive about the ability to have a higher growth rate in the outer quarters than we did in Q1 in our pharma business.

Yes. And we are expecting a faster growth in Q2.

Yes.

Okay. And then maybe one again for you, Mike or maybe even Sam. It feels like 1Q is always a good time to ask this question, just given that most are heading down to AGBT. Any update you can give us on Lasergen product development? How much of a focus is that at this point? And then maybe what are you looking at in terms of the change in total investment there if we compare 2020 to 2019?

So I think, Sam, you are getting our bags packed, maybe at least now your team is getting their bags packed to head to that. You are staying home. That's right. Okay. Maybe just a few comments on this.

Yes. Overall, thanks for the question, Dan, if you would have heard my comments already from JPMorgan, we are making progress on a number of fronts related to the development work we are doing on the Lasergen sequencer, particularly as it comes to the technical specs on our read length, on our quality and so forth. So we are continuing to make that progress. When you think about AGBT, of course, it's not just about sequencers, it's about the overall NGS workflow, it's about really looking at beyond NGS, the overall genomics. So we are excited about Magnis, which we introduced not too long ago. We are seeing, sorry to remind you, Magnis is this really walkaway automation for taking DNA libraries or actually putting DNA in and being able to come back and just load that directly onto your NGS sequencer. We have seen some really good interest in that in Europe, in America and in China. So we are going to continue sharing the message there and sharing some data from a number of customers. We also, as you would have heard us talk about, we have launched a new SureSelect XT HS2 DNA reagent kit which allows us to look at even lower starting amounts, down to 10 nanograms of DNA for FFPE which is very important for cancer. It also allows on Illumina sequencers. It's very important to be able to use molecular barcodes. We have that going on as well. And then we have a number of partnerships that we are working on with a number of customers and collaborators. So stay tuned. I think it's going to be an exciting AGBT.

Yes. And Dan, the other part of your question was --

Investment outlook.

Yes. So just quickly, our spending forecast in 2020 is the same as 2019. So we are not expecting any ramp up.

Okay. I appreciate it. Thank you.

Your next question comes from Derek de Bruin from Bank of America. Your line is open.

Hi. Good morning or good afternoon. I have got a number of questions.

Sure.

First one is, I guess just on the gross margin outlook for 2020. Can you sort of walk it through the next couple of quarters in terms of how that looks?

Yes. We talked about at the beginning of the year, our guide was contemplating roughly a flattish gross margin across the company and that hasn't changed. So we have always said that the first half of the year, with Q1 being the hardest of comparison because of the startup costs in NASD and you can see that kind of in our numbers. We also were affected a little less, as we mentioned before, in LSAG. We would expect that to recover as we get through the course of the year. So at a high level, Derek, I would expect our gross margins still to be within that range, roughly flat year-over-year. And where we are getting our operating leverage is really in the OpEx expense line.

And Bob, I think we are also looking to see maybe more favorable mix in our instrument business as we move forward. And I made some comments about the pricing pressure that we saw more of a calendar year end kind of phenomenon with pricing more stabilizing as we started the 2020.

Yes.

Well, great. That segues into my next question on instruments. And so I think you had said last quarter, you were expecting may be flattish instruments for the full year. Is that still sort of your expectation? And that leads into, any idea of sort of what pent-up demand could be? I mean do you sense from customers, particularly in C&E, if there's people waiting on the sidelines to buy when the budget gets better? I am just trying to get a sense of what the instrument dynamic looks like.

Yes. Hi Derek. This Bob. I think the short answer on your first question is, yes. We are still in that range of roughly flat. Actually if you looked at Q1, we were down 2% core, but if you adjust it for the Coronavirus, it would been down about 1% on the most difficult comp that we had. To your point around C&E, there have been chutes of life and some of our customers looking at things. Now what I would say is the Coronavirus kind of froze some of that into question. But I would say, that's still intact right now. I don't know. Jacob, if you have anything?

No. Overall, I do think that there is some pushed out pent-up demand here. And eventually, there will be a tech refresh. And we have invested over the past period quite a lot into our instrument portfolio and really refreshed across the whole portfolio. So when that pent-up demand is coming forward, we are ready. But we just can't call it right now exactly when that's going to happen.

Yes. Jacob, I will just add one thing. Early on in my tenure, we had a similar kind of slowdown in the C&E. The difference here is that, at that time, a lot of our platforms were rather aged. This time, we have a completely refreshed platform. So it also is a great productivity message there to customers. And our lab managers also have the ability to go to their management and say, listen, there is something new out there. I am not buying this, I am replacing like-for-like.

Great. And then just one, maybe I missed something, but you did 3.7% contribution from M&A in the first quarter, 3.5% to 3.7% in the second quarter and then the guide for the full year is 2.85 to 2.9%. Is it something else in the first half besides BioTek? And if not, why are you expecting a step down?

So you have get very good math and we are not expecting a step down. The only thing that's in the numbers and that could be an area of potential opportunity.

Great. Thank you.

Your next question comes from Brandon Couillard from Jefferies. Your line is open.

Hi Brandon.

Mike, just on a separate topic.

Sure.

Can you sort of speak to the Twist settlement last week? Why only $25 million? And should we expect any legal savings from having that case out of the way now to reinvest those dollars?

Yes. So first of all, just a few comments on the settlement. So we are very pleased with the agreement that was reached with Twist. As you know, we think it's in the best interest of our shareholders to rigorously protect our IP. And not only in addition to receiving a payment from Twist, they also had to procure a license from us for certain aspects of our oligo synthesis technology. And we are really a company that's committed to doing innovation in the right way. So we are really pleased with how the settlement goes. And Bob relative to the treatment of the legal expenses and outlook for the rest of the year? I think we have that in pro forma, right?

Yes. We will pro forma that.

Yes. So you will see both the settlement come in, Brandon, as well as the costs associated with that, I guess, in our Q2 results.

That's right.

Thanks. And maybe one more higher-level question for you, Mike.

Sure.

I mean you mentioned sustainability, that recognition. Clearly, that's becoming a much bigger focus I think for the investment community. Can you just help us contextualize that focus may help contribute to your growth or cash flow or differentiate you in terms of the customer base?

Yes. It's a great question. So as I mentioned in my call script, we have been doing these things because we thought it was the right thing to do and now people are really paying attention to it. So I think it helps on multiple aspects of the business. So first of all, relative to our new products which have a very favorable environmental impact, there is real compelling reason for customers because a lot of our most important customers have their own sustainability initiatives and they are very interested. I have several European customers I am visiting next month and they want to hear about our sustainability plans. So when you talk to them about how we are reducing the footprint, the electrical consumption, that some of our products don't even use gases and that we have eliminated the use of gases and gas chromatography in the case the NPIs and we are reducing the size of the packaging. And by the way, that also comes with the benefit to Agilent's P&L. So it really helps in terms of our customer relationships and our ability to drive sales into those accounts. And also it is really quite helpful for recruiting of new employees into the company. New employees when they are looking at potentially joining the company really want to know what Agilent stands for when we talk to them about our culture and what we do as a company in the local community, what we do for the environment, our views on diversity and inclusion. I think it really is a powerful message to attract new employees to Agilent, but also for those who are part of the Agilent team to really be proud of the company they work for and be energized about where the company is going forward. I think we have talked before, I am a big fan of sports and if you build a great team, you get great things happen in the marketplace or on the field. And I think that really is really one of the major benefits you get here which is what it does for your team. So it really is a multitude of impact for the customers, I mean for the company and something we really believe in.

Okay. Thank you.

Your next question comes from Vijay Kumar from Evercore ISI. Your line is open.

Hi guys. Thanks for squeezing me in.

Hi Vijay.

One, maybe on China, Mike. We have heard some chatter of possibly the government initiating some sort of stimulus here to kick-start the economy. If that were to be the case, where would that impact fall? Is that in C&E and food? Is that where we would see your China numbers coming up?

Well, I have to say I have heard some rumblings of stimulus, but I haven't seen anything around the specifics of what a stimulus would be. I don't know Bob or whether you have anything to add.

No. I think you are getting --

That's a likely area.

Yes. Exactly, I think that's a likely area. That and pharma.

And also, I would also expect environmental as well. So that would be my guess, because these are major quality of life initiatives that the Chinese government has been behind. So my guess is that's where they would put the stimulus. But again, we don't have any specifics. That would just be pure speculation on my part at this point in time.

Understood. And Bob, a quick one on the EPS guidance here. I see that the tax rate ticked down sequentially on the guidance front. Did anything change on the margins at all because it looks like the revenue range remains unchanged? So I am wondering if this is below the line or margins some sort of impact here?

Yes. Nothing material, Vijay.

All right. Thanks guys.

You are welcome.

Your next question comes from Steve Beuchaw from Wolfe Research. Your line is open.

Hi and thanks for the time everybody.

Sure, Steve.

I guess first I wanted to start with Bob with just a question about one of the underpinnings of the outlook for the year that hasn't been touched on so much just yet and it's NASD, maybe a two-parter on NASD. One is, do you think we feel good about getting to a few dozen millions of dollars of contribution from NASD? And then can you give us any perspective and I guess maybe this is a Sam question, as to how much of the capacity on the new facility in Fredrick is now contracted? And then I have one for Mike.

Sure. Yes. Let me make sure I answer your question correctly. What I would say is, Q1 came in slightly better than what we expected on the ramp. So we feel very good about that trajectory. Obviously, you know the second half of the year is going to be significantly greater than the first half of the year as we ramp up that business. And I would say that the order book, we feel very good about.

Yes. And maybe Steve, to build on what Bob said. We have said that there is a ramp rate that we have been planning all along. That's what we are seeing. So as you really get into Q4, we will be much more in the run rate, if you will, of what to expect going into financial year 2021 in terms of the Frederick site in particular. So it's ramping as planned. It is being utilized. We were happy to produce good product and good revenue from that in this quarter again after starting last quarter. And further to what Bob said, a lot of these programs and projects are long lead, both working with our customers to really lay the groundwork and do the work. So though I can't tell you exactly what percentage, I do feel good about the percentage of programs and projects that we are already lining up going into next year.

And Steve, if I could just amplify one of the points that Sam made. It was absolutely crucial that those first batches we produce for customers met their expectations. And as you know, we are very cautious in terms of how we started positioning the ramp here because we just had to get it right and we have gotten it right for those first few customers. I think that really positions us well when we look at the outlook for the rest of the year.

Okay. That makes a ton of sense. Thank you for all the color there. And then Mike, I wonder if we could just do the zoom-out thing, if you will, where we think about the full year. I mean there are so many moving parts, right. And the Coronavirus certainly makes it more complicated. But if I rewind to 90 days ago or so, there was a perspective, not necessarily from Agilent, but certainly in investor conversations that the outlook for fiscal 2020 was really conservative or significantly conservative. And I think we have, of course, heard from you guys over the years, outlook that started at one point and you pretty consistently do better than the outlook. I wonder if you could just give us your perspective on the outlook and guidance philosophy now that you know 90 days more than you did at the time you gave the outlook at the beginning of the year, to what extent is this middle of the fairway, to what extent is this conservative? And as you talk to your customers and you think about the outlook, I mean, how are you feeling and how has that evolved, just again really zooming out? Thanks so much.

Yes. Steve, so I am in the conference room zooming out right now and great question. And I think that that's how we thought about the full year guide, which I will leave it to you to prescribe the first adjective. I mean there were proper adjectives, but we started this year with a guide that we thought was relatively the floor of what we could do and talked about areas of potential upside for the business. And we were actually tracking well in the first quarter where it would have been a beat, both on the revenue and EPS side of the quarter, albeit the impact of the much talked about today the impact of the Coronavirus. So that's why we felt pretty confident about our ability to say, listen, there are still a lot of puts and takes relative to China in the near term, but there are other aspects of the business are doing extremely well outside of China, whether it be NASD or ACG business. The compares and the strength of our LASG instrument portfolio, that's gone on NGS. So we have a lot and then back to cell analysis. So we have a lot of confidence and whether we call it a middle of fairway right now, but we feel pretty good about --

Yes. I would say, Steve, one thing. Obviously 90 days ago, we didn't have the epidemic that we are seeing right now which is unprecedented. And so what we are trying to do is we are seeing, hey, in the first half of the year, we are expecting a $25 million to $50 million impact that we are going to make up in the second half of the year. Now the question is, how fast. And we hope for everyone's sake that that will ramp up fast and we will get this behind us. But that's certainly puts a lot more variability in our forecast. We feel good about where our forecast is. But we certainly didn't anticipate that at the beginning of the year.

Okay. I really appreciate the color there. Thanks for bearing with me. I appreciate it.

Sure, Steve. Great question.

Your next question comes from Bill Quirk from Piper Sandler. Your line is open.

Great. Thanks. Good afternoon everybody.

Good afternoon Bill.

Hi Bill.

So I guess Bob or Mike, just update on M&A. You had mentioned on the last call that you would be considering looking at larger deals in and around $1 billion. Just curious what the update is?

Yes. I think the statement I made in last quarterly call remains which is, we think that deploying our capital towards growth and earnings drivers on the M&A front makes a lot of sense for our shareholders in deals that makes sense for us, in markets that we know where we can really leverage the scale of the company. And we did our largest deal, BioTek, the past quarter. And as you heard earlier, that's off to a really good start. I think we often get the question, well, how large you are willing to go? And the way, Bob and I have described it is, listen, we could go maybe multiples of that. But we are looking to stay in our lane here and not do anything that's magnitude larger than a BioTek. So I am not saying that BioTek is the max level. But probably multiples of that as opposed to something that's of a magnitude size.

Yes. And Bill, as you can appreciate, timing there is always very difficult to understand and we are going to remain disciplined. And if there isn't anything out there that would meet our financial criteria, we are not going to do it. We don't need to do M&A to make our model work. But certainly, you see in the first quarter the benefit that we have seen with BioTek and really building scale in cell analysis, which we think has a long term growth opportunity for us, not only in LSAG but across the business.

Understood. And then just secondly, I guess kind of a bigger picture question about the pacing of CrossLab. Over the course of the year, we are going to be heading into slightly more difficult comps for the next couple of quarters?

Yes. The beauty of ACG has been it's predictability across the business and we are not expecting any dramatic change in the back half of the year with the possible exception of slightly an elevated ramp in China. But that business that Mark and team have built has been just phenomenal in terms of providing stable high growth and profitable growth over the course of the last several years. And I think that that, quite honestly, is a great legacy to what Mark has been able to accomplish. And not only that, it really speaks to what our customers are looking for in terms of productivity in the labs and so forth. So we would expect that to continue to kind of chug along as we have talked about in the past.

Got it. Thank you very much.

You are welcome.

All right. Thanks everyone. With that, we would like to wrap up the call for today. Have a great rest of your day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.