安捷倫 (A) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2016 Agilent Technologies Incorporated earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded. I would now like to turn the conference over to Alicia Rodriguez, Vice President of Investor Relations. Please go ahead.

Thank you, Sabrina, and welcome, everyone, to Agilent's second-quarter conference call for FY16. With me are Mike McMullen, Agilent's President and CEO, and Didier Hirsch, Agilent's Senior Vice President and CFO. Joining in the Q&A after Didier's comments will be Patrick Kaltenbach, President of Agilent's Life Sciences and Applied Markets Group, Jacob Thaysen, President of Agilent's Diagnostics and Genomics Group, and Mark Doak, President of the Agilent CrossLab Group.

You can find the press release and information to supplement today's discussion on our website at www.investor. Agilent.com. While there, please click on the link for financial results, under the financial information tab. You'll find an investor presentation, along with revenue breakouts and currency impacts, business segment results, and historical financials for Agilent's operations. We will also post a copy of the prepared remarks following this call.

Today's comments by Mike and Didier will refer to non-GAAP financial measures. You will find the most directly-comparable GAAP financial metrics and reconciliations on our website. Please note that we will refer to core revenue growth, which excludes the impact of currency, the NMR business, and acquisitions and divestitures within the past 12 months.

Unless otherwise noted, all references to increases or decreases in financial metrics are year-over-year. Guidance is based on exchange rates as of the last day of the reported quarter.

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.

Before turning things over to Mike, I'd like to remind you that Agilent will host its analyst and investor meeting in New York City on May 25. Details about the meeting and webcast are available on the Agilent Investor Relations website. And now, let me turn the call over to Mike.

Thanks, Alicia, and hello everyone. Thank you for joining us on today's call. The Agilent team delivered another strong quarter, both Q2 revenue and earnings were above the high end of our guidance.

Let me highlight three key results: First, revenue growth was up more than 8% on a core basis. Second, we delivered adjusted operating margin of 19.4%, an increase of 110 basis points from a year ago. Finally, EPS of $0.44 was up 16% over last year.

Before moving on to a review of our Q2 results, I do want to address our year-over-year quarterly comparisons, which reflect unusual event from last year. The 8% core growth that we are announcing today, about 1.5 percentage points, is due to a shift of revenue last year from Q2 2015 into Q3 2015. In the second quarter a year ago, we experienced $15 million of shipment delays due to start-up challenges with our new US logistics center.

In addition, our process improvement efforts over the past few quarters to convert incoming orders more quickly to revenue have paid off. We have reduced our order to revenue cycle times, particularly in China. Consequently, some shipments initially forecast for Q3 of this year were delivered in Q2.

Agilent's strong Q2 results were led by double-digit core growth in pharma and food markets. We also experienced continued strength in academia and government, environmental, and diagnostic and clinical markets. All end markets grew, except chemical and energy. Growth was broad-based across most of our portfolio. Geographically, all regions grew except Japan, led by very strong growth in China.

Let me highlight our Q2 results by business group. The Life Science and Applied Markets Group delivered core revenue growth of 8%, led by strong demand in the pharma and food markets. About 3 percentage points of the 8% increase was thanks to a softer compare, due to the timing issues mentioned earlier from last year's US logistics center startup. The combination of strong top line growth, expense management, and gross margin improvements, partially due to the NMR exit, drove LSAG's operating margin to 19%, up 320 basis points from a year ago.

LSAG continues to strengthen its portfolio. In Q2 Agilent introduced VistaFlux software. This new software speeds up clinical research data analysis, so scientists can more quickly understand the underlying causes of diseases, such as cancer. VistaFlux strengthens Agilent's leadership position in metabolomics.

Last week, We announced a new Agilent 1260 Infinity II LC at the Analytica trade show. This instrument provides best-in-class lab efficiency, and improves the performance of full backward compatibility.

Next, the Agilent CrossLab Group continued to deliver consistently strong revenue results. Core revenue growth in Q2 was 10%, led by strength in contract services, LC columns, and lab supplies. Expansion and penetration into Asia continued to be strong contributors to our growth. Operating margin was flat versus a year ago at 21.5%.

CrossLab represents a strategic transformation of our services and consumables business. I'm pleased to report that Agilent was recognized with the 2016 Reviewers Choice award for customer service. This award is from Select Science, an independent, expert-led scientific review. This is the second year in a row that scientists in North America have judged Agilent's customer service to be the best in the laboratory products industry.

Finally, the Diagnostics and Genomics Group delivered 5% core growth in Q2, against a difficult compare. The pathology business continues on its steady trajectory back to market growth rates. Highlighted by strong demand for our new PDL1 companion, and complementary diagnostic test. Genomics showed strong market performance, led by our SureSelect Target Enrichment, and our Array CGH offerings.

DGG's operating margin was flat versus a year ago, at 15%. In Q2, Agilent announced an $80 million investment in Lasergen, an emerging biotechnology company with innovative next-gen sequencing technology. Our two companies will collaborate on building an NGS work flow for clinical applications.

In Q2, Agilent also announced that commercial availability has expanded to the EU for our new PD-L1 diagnostic test for non-squamous non-small cell lung cancer. This diagnostic was developed through a collaboration with Bristol-Meyers Squibb, the maker of OPDIVO.

Now I'll provide an overview of Agilent's core revenues by end market. Life Sciences and Diagnostics markets saw a continuation of our first-quarter performance, with strength across all end markets. Pharma grew 14%, fueled by technology refresh deals, new product uptake, and sustained growth in the after market. This is the fifth consecutive quarter of greater than mid to high double-digit growth in pharma.

Academia and government grew 7%, driven by strong demand in China, and an uptick in the US. Clinical and diagnostics also grew 7%, with strength in genomics led by Target Enrichment and Array CGH.

Applied end market performance was mixed. Flu was up 25%, with strong sales in China and the Americas. China also drove 6% worldwide growth in environmental and forensics. Chemical and energy declined 3%, reflecting continued macroeconomic concerns, and the effects of lower oil prices.

Now I'll turn to an update on our operating margin improvement initiative. Q2 marks the fifth consecutive quarter of year-over-year operating margin improvement, delivered by the new Agilent team. This is a result of our ability to outgrow the market, while driving operational efficiency improvements.

Our multi-year Agile Agilent program continues to simplify the Company, making us more nimble and lowering our costs. Our execution of Company-wide streamlining of organizations, processes and systems continues to be on track to deliver incremental savings in 2017. For example, in Q3, we will take a major step forward in simplifying the Company's systems infrastructure with all of our financial systems now on SAP.

On the capital deployment front, we paid $37 million in dividends, repurchased $94 million of Agilent stock, and invested $80 million to enable our NGS workflow strategy. Finally, our One Agilent initiative is driving a well-received cultural transformation to improve cross-Company collaboration and delivery of results. At last year's analyst and Investor Day, I described the shareholder value creation model for Agilent to be driven by outgrowing the market, expanding operating margins, and a balanced capital allocation policy.

I'd like to take a minute to position the Q2 results in the context of our longer term goals. After delivering our highest annual core revenue growth since 2011 of 6.4% in 2015, we have now had two strong quarters to start 2016, including this quarter's 8% core revenue growth.

Since the new Agilent leadership team was put in place, the team has delivered year-over-year operating margin improvements every quarter. We have completely offset the initial $40 million of dyssynergies from the Company's split. In FY15, we returned $400 million to shareholders, and $370 million year-to-date in 2016 through cash dividends and share repurchase.

From 2015 until now, we have also invested about $400 million in new business via M&A and equity investments. Didier will share more specifics later, but we are raising our full-year 2016 outlook for core growth, operating margin, EPS, and cash flow.

Let me now talk about our second-half 2016 forecast, in light of what we have already achieved in 2016, and what we plan to deliver in 2017. When we look at today's overall market environment, while we face increasingly tough compares, we expect strength in pharma to continue in the second half of 2016 and into 2017. China is also expected to remain strong in second half 2016 and 2017.

Taking a closer look at the chemical and energy market, we have been experiencing a more prolonged and steeper slowdown than initially anticipated. We are now forecasting overall low single digit market declines for the year, versus our initial flat guidance assumptions. The oil exploration segment of this market has been down significantly for some time, with a recent well reported spillover into the refining segment.

There are initial indications, however, of a bottoming, with increased deal activity in the large chemical segment of the market. We are projecting an improved chemical and energy market environment in 2017. We are assuming we will continue to face headwinds in this market for the remainder of 2016.

We are currently modeling 2017 with an above market core revenue growth of 4.5% at the midpoint. This is in line with our projected full-year 2016 core growth rates, but higher than our expected core growth rate in the second half of 2016. There are two reasons for this increase:

First, we expect to have a very strong new product introduction in the second half of FY16, which will drive revenue growth in FY17. Second, on the end market front, we expect chemical energy to have bottomed out by year-end, accompanied by continuing solid conditions in all of our other end markets, and in China. Overall, we remain on track with our 2017 goal to outgrow the market, and improve our operating margins to 22%.

Looking inside the Company, I can share with you today that the One Agilent team is working well together, and is driven to win in the marketplace. I look forward to seeing many of you at our analyst and investor day, where I'll share our progress versus our commitments, how we will sustain our improved performance, and the longer term outlook for the Company.

Thank you for being on the call today. I will now turn it over to Didier, who will provide additional insights on our financial results and guidance for the third quarter and full year 2016. Didier?

Thank you, Mike, and hello everyone. As Mike stated, we delivered strong performance this quarter, again. 8% core revenue growth, 110 basis points of operating margin expansion, and $256 million in operating cash flow. After adjusting for last year's $15 million slippage in revenue from Q2 to Q3, as we launched our new US logistics center, our core revenue growth of 6.5% remained well above market.

During the quarter we bought back $94 million of stock and paid $37 million in dividends. Finally, on May the third we successfully moved all finance applications from Oracle to SAP, which is our main ERP. This will result in significant simplifications of our finance and IT operations.

I'll now turn to the guidance for our third quarter. We expect Q3 revenues of $1.03 billion to $1.05 billion, and EPS of $0.45 to $0.47. At midpoint, revenue will grow 1.3% on a core basis, or close to 3% adjusting for last year's $15 million impact from the US logistics center. And turning to share repurchase, we expect to buy back $93 million this Q3.

Now to the guidance for FY16. We are raising the midpoint of our revenue guidance by $60 million, including $50 million due to currency. As a result, we're increasing our core revenue growth guidance at midpoint from 4.25% to 4.50%. We're also raising the midpoint of our EPS guidance by $0.06, including $0.03 coming from currency, and $0.03 from operational performance.

And one important note. After further review, we and our auditors have concluded to account for the Lasergen investment using the cost method of accounting. This means that we'll not book our share of Lasergen loss as previously communicated.

Finally, we are raising our operating cash flow guidance from $650 million to $740 million, and there is no change to our CapEx guidance of $140 million. With that, I'll turn it over to Alicia for the Q&A.

Thank you, Didier. And Sabrina will you please give the instructions for the Q&A?

(Operator Instructions)

And our first question comes from the line of Dan Leonard of Leerink Partners. Your line is now open.

Thank you. Two questions. First off, can you elaborate on the business trends you're seeing in Europe? And secondly on the pharma end market, can you talk about what gives you confidence in the FY17 outlook that you have yet another strong year in pharma, following two years then of tough comps in capital markets, which have been more or less shut? Thank you.

Thanks, Dan. I think I'm actually going to pass that over to Patrick who is just back from a trip to Europe, and maybe can provide some insight on what's going on in Europe, and then also could pick up the question on pharma as well.

Sure, I'm happy to. So let me start first giving you some insights on Europe. We have seen actually some decent growth in central Europe. We had seen some weakness on what we call the IDR states, Eastern Europe and that's mainly driven by the chemical and energy market, or the energy market on that side.

In central Europe, there's definitely strength in Germany and other states around that. We still see some issues on the academia and government side. It is rather flat. But pharma, for example, is also very strong in Europe.

For your pharma question, overall, we are confident that we will continue to see pretty high growth in pharma for the remainder of this year. We target low double-digit growth for pharma, and looking into 2017, we think the pharma market will continue to be strong for us, driven by two factors: We see a continued demand in the replacement business, and as you probably know, we just launched at the Analytica conference, we launched our new 1260 Infinity LC series as an example, together with the InfinityLab consumables and service, and we think that will drive -- continue to drive a lot of good replacement business for us in pharma. And then we see also continued demand in the biopharma space, that are looking for new solutions helping with these more complex molecules in terms of analysis, and we have very comprehensive offering for that space, as well.

Thanks, Patrick.

Great. Thank you.

Thank you. And our next question comes from the line of Jonathan Groberg of UBS. Your line is now open.

Congratulations on another great quarter, Mike.

Thank you, Jonathan.

Can you maybe elaborate a little on -- I think you said core guidance, and if I'm looking at your presentation, core revenue growth guidance in the third quarter is pretty precise at 1.3%. I think I just heard you still expect pharma to grow low double digits. Could you give a little insight as to what you're seeing in the third quarter?

What we looked at was, what's our growth rate that we've had over the first half of this year, and as we looked into Q3 and Q4. And what I would point to is a couple things, Jonathan. First of all, tough compares, and this is inclusive of a few one-time moves between quarters, which actually were driven by improvements in overall operations.

So as Didier mentioned, we had this $15 million shift in Q2 of last year into Q3, which when we had our startup issues with our new logistics center. If you adjust for that, that gets you about 3% growth. The other thing we saw happen in Q2 was, we were working really hard to improve the overall cycle time, from the time a customer places an order to actually install, and we can recognize the revenue.

In Q2, we actually exceeded our expectations, and it got there a lot faster than we had thought. And what that meant was we had a significant amount of revenue, probably $20 million to $25 million that came from Q3 into Q2, where we initially had forecasted into the second, third quarter. All in all, if you take into account those things, you've got more of a consistent growth scenario between Q2 and Q3.

I would tell you, though, the chemical and energy is still looking for a bottom, and that's why we have that outlook for the year, which basically it's down, it's going to stay down for the rest of the year. There are some signs it could be getting better, but we are not convinced yet we've seen the bottom on chemical and energy. The combination of those tough compares, as well as our outlook on chemical energy is what's driving the overall guidance for the second half.

Okay. That's helpful. And then, I guess just one more. Are there any -- sometimes when we see shifts onto one platform, like Oracle to SAP, is there anything at all, any wiggle room you've left there, in terms of hiccups in the quarter, or maybe just --?

You're exactly right, Jonathan. The wiggle room we left was, we made sure we went live the first month of the quarter, and Didier's in the conference room here smiling. I don't know if you want to add any additional color on how it's going so far?

It's going very well, the migrations and the startup of the operation, there was zero disruption. Obviously, we expect to have to deal with some stabilization activities throughout the quarter. We'll do two close before we do the quarterly close, so everything is -- we couldn't be happier about how it went.

And you're correct, it is a very complex endeavor, one that we are pretty used to. We've done a few of those in the past. But still, it remains a very complex endeavor, and we are really happy how smoothly it went.

Jonathan, as I pointed out in my script, this is one of the Agile Agilent initiatives, which you'll start to see pay off in our cost structure as we move into 2017.

Great. Thanks a lot.

Thank you. And our next question comes from the line of Tycho Peterson of JPMorgan. Your line is now open.

Just following up on that last point on the SAP margins, can you maybe -- on the margin impact. Can you maybe quantify how much that could play on margins for this year?

For 2016 I think it would be very limited at best, Tycho, because we'll be running some duplicate backup systems, and then the other aspects of our spend really don't come out until 2017. I'd really position that, and I'd ask you to think about this more as a 2017 impact but a proof point of why we think we're going to be able to improve our margins again in 2017.

And then academic, 7%, can you maybe just talk as to whether you're seeing an acceleration there? What you saw this quarter?

What we saw in the last quarter is really strong performance in China, and some increased signs of life in the US side of things. That's what we pointed to an uptick. Not a lot of significant moves on the European side. It's mainly a China story, and I think if there would be upside to it, it would come from the US, is how we're thinking about it.

Okay. And then lastly, just in terms of pharma, obviously that's been a nice driver. Can you maybe talk about where you think we are in the LCMS upgrade cycle, and how much your growth going forward is going to be contingent on R&D budget expanding versus the upgrade cycle?

Sure, Tycho. Great question. Patrick, I know you looked at this pretty closely. What's the updated view on that?

I think there are two cycles we're looking at. The first cycle we went through was the upgrade cycle from sell HPLC to UHPLC, which is still ongoing but a considerable part of that probably has been done. When you look at the installed base of instrumentation, it still deals with core LC, and this is where we are targeting with the Infinity II series right now. There's still a lot of replacement pending out there.

Just as a reminder, we had probably about 150,000 systems out there, based on the 1100, 1200 platform, which over time will be up for replacement. We are positioned extremely well with our platforms, because it's 100% backwards compatible, and we are also able, for example, to emulate some of our competitors' systems on our platforms with the technology we call ISET, Intelligent System Emulation Technology, and that actually compares very nicely with our customers, and gives us a unique advantage in the market.

I think we see both those having legs through 2017.

Absolutely. I think this goes on into 2017, combined again with the [dryer PC] coming out of biopharma.

Thank you.

Thank you. Our next question comes from the line of Jack Meehan of Barclays. Your line is now open.

I just wanted to start, the better -- at least relative to what I was looking for, looked like you had better gross margins in the LSAG segment, now two quarters in a row. Can you talk about what some of the notable changes there are? Is there anything with product mix that's driven the improvement, or do you think this is the new norm to look for?

Let me make some initial comments and then Didier or Patrick, if you can build to it. In terms of product mix, part of what you're seeing is the fact that we are winding down through our P&L the impact of the NMR business. I think you can see the benefit of that exit decision on the P&L, because it really has been contributing to the improved gross margins. That's not the whole story.

The other story is obviously the strong demand for the products, and the volume benefits we're getting, as well as the focus on taking cost out of our material, costs out of our business. As well as we talked a lot about logistics last year. We can also talk about logistics this year, which is we're doing a much better job in terms of overall logistics operations. That's blowing through on the P&L as well. So Didier, I'm not sure if I missed anything else.

You covered it all. Thank you.

Just one more for the adoption of the companion diagnostics, now a few quarters into the launch. Are you in a position, could you maybe help us size what take business is today, or just in the market, what you think you hold in terms of market share? Thanks.

Why don't you take that, Jacob?

Thanks for that question. And we are definitely pleased with the pickup of the PD-L1, and this continues during the last -- basically it's now three quarters. The market is still very early. We still really only in US, we have had a few press releases here. Lately, also, we're reentering into Europe, but we're just scratching the surface in Europe.

Furthermore, it's still a second line -- it's still addressing the second line treatment, and if that also goes to the first line treatment, the market will become significantly larger. At this point in time, it's still small revenue in the bigger scheme of things, but I do believe that the PD-L1 has an opportunity to be as big as the HER2 market. However, I will also remind you there are at least four, probably five different potential drug and companion diagnostics out there that has to share that market. So still early days, but a great opportunity.

Thank you. And our next question comes from the line of Brandon Couillard of Jefferies. Your line is now open.

Mike or Didier, could you give us the China growth rate, the percentage change in the quarter, and if you could speak to demand in the food area outside of China and Asia, that would be helpful?

In the China result for Q2, what we've been pointing to is strong double-digit growth. So it was a very, very strong quarter for us in China. I would remind you though, part of the strong growth was not only the strength in the market, but that those operational efficiency improvements I talked about, where we really had shortened the improved cycle time from orders to install, that was really dramatic in China.

So the overall business is going to be quite strong through the year. You should not expect strong double-digit growth every quarter, though, for Q3 and Q4. But overall, China is, to complete the story here, when we came into this year, we thought that the overall performance for Agilent in China might be high single digits. We're now looking at low double-digit growth in China for the full year.

Thanks. One more for Didier. I notice you bumped the operating cash flow guidance of about $90 million. How much of an impact does the -- I noticed the tax refund benefit. If you could quantify that, and just help us bridge the delta between prior versus new?

The overall tax outlays forecasted for this year were, I think, about $10 million less than what we had anticipated in our initial guidance, $10 million or $15 million, and the rest is really operational performance, improvements in our working capital, management, and FX, and then just our operating profits.

Super. Thank you.

Thank you. And our next question comes from the line of Ross Muken of Evercore. Your line is now open.

Mike, since taking over it's obviously been a pretty hectic journey, and your messaging from the beginning has been pretty consistent around growth in margins and returns. Obviously, the last few quarters you started develop a cadence, last quarter results were good, but we had the challenges on FX. Do you feel like this is the first quarter where you feel like you got to deliver the full bag, where you were able to drop through the top line outperformance, which is clearly better than market, you drove the margins, you're buying stock, the returns are up, the cash flow's good, that you were finally able to show the market that the business model's working, and that feeds, I guess, into your confidence also, I would assume, on 2017?

I couldn't have said it better myself. Thanks, Ross, for the question. I think that we've been working really hard over the last four or five quarters with the new leadership team, and as you look at -- everything came together this quarter. We've had strong growth.

We've had improvement in our operating margin as I pointed out in 2015, but all the vectors really came together nicely in the second quarter. And I was particularly pleased on some of the more operational activities we've been working inside the Company. That may not always be so apparent initially on the outside world, but you start to see it in the results. The fact we've addressed our logistics challenges.

I have to talk about year-over-year compares, but it's fixed, and actually, now it's contributing to improved results. Yes, we had to talk about the shortened cycle time for orders to revenue and have brought in some revenues we initially had planned for the third quarter, but we made these operational improvements, the cycle times are shorter, and this is now the new normal.

So I guess that would be the closing comments, which is yes, we're in a new normal for the Company. We've got a lot of confidence about 2017. Perhaps steal a little bit of my thunder for the analyst meeting next week, but still hope everyone attends. But when you start having these proof points, quarter in and quarter out, I think it starts to show you the team is delivering, and I think the results are now starting to be appreciated and believed.

Great. And maybe quickly just on Seahorse, can you just give us an update on how that business is performing relative to your expectations, and how it's plugged in, and where you're seeing maybe the early fruits and some cross-synergy with the existing business?

Yes, in fact, very timely question, Ross. We just had our 180-day review this morning and Patrick, why don't you go ahead and share a couple highlights from that session?

Sure, absolutely. What I really would like to highlight is how seamlessly the integration of Seahorse went. We are now six months in integration, and we would say we're targeting full integration by June, which means basically we have implemented all of the systems, which is a pretty fast pace.

At the same time, we are seeing the positioning of Seahorse within our portfolio really works out. We're seeing nice deals and combined sales of LCMS and Seahorse in areas like disease research and disease discovery that is actually exactly where we thought, it's complimenting our strength in metabolomics with the life cell metabolism which Seahorse brings to the table. This is a very nice story that resonates very well with our customers. Again, on the integration side, we're very pleased with where we stand, and we're looking forward to a very successful second half.

Ross, I'd just add two things: the comment you I made to the team this morning is this is the fastest I've seen us do an integration. These things usually plod along for many quarters, in some cases, for years. This one is moving along really, really fast and we're getting some wins. In fact, we won an LCMS deal because of Seahorse. So it's the complementary nature of the portfolios is starting to work.

Excellent. Thanks.

Thank you. Our next question comes from the line of Paul Knight of Janney Montgomery Scott. Your line is now open.

Mike, the move you made to creates CrossLab seems to be gaining traction. Can you give us a little background on CrossLab, in terms of who do you think is taking -- it's taking share from somebody at that growth rate. Could you give us more color on CrossLab?

As you mentioned, that was a major strategic move where when we set up the Company, we established the Agilent CrossLab Group. We had this vision about how we could really attack and go after the enterprise-wide services and consumables opportunity. And as you see, Mark and the team have really been delivering. We know that the customers are responding to the value proposition that Agilent offers, both in terms of how our service capability is viewed, and that's why I mentioned in my script about the external recognition we recently received.

But they also appreciate the fact that we're able to give them insights, in terms of actually helping them improve their business operations, and we're seeing a real strong demand for this in the pharma, and growing interest in other parts of the applied markets. So we know that we're growing faster than some of our competitors in this space. We also know that there's only a few companies really trying to go after this type of business.

I believe this is where the market is already going to, and I think you want to be a player here. I'll leave it to you guys to figure out who's losing share. As you can see, all I can tell you is we're growing close to double-digit in this space. So it's an attractive move for us.

Thank you. And our next question comes from the line of Tim Evans of Wells Fargo Securities. Your line is now open.

Congratulations on a good quarter. I just wanted to make sure I understand the variance in the quarter relative to what you were expecting. I believe you had called last quarter for 4% core growth, and we saw 8% this quarter. I hear you, that it sounds like about half of that variance, about 200 basis points, was from the better book backlog to revenue conversion this quarter.

And I know you also called out the compare relative to last year. But that compare should have already been known. So I just want to understand what's the other 200 basis points, that really surprised you in the quarter?

Sure, Tim. How about if I -- again, thanks for your comment. I can give you a few dollar numbers of revenue impact, the way we've been looking at it, and you can do perhaps the math on the impact on the growth rates.

But what we saw relative to our initial expectations for the quarter were really -- first of all, it starts with the market. The overall market demand came in, as we predicted. We saw good growth across the entire portfolio, led by pharma and food markets, and China, as you heard earlier.

But I'd ask you to look at two things: one is this higher conversion of orders to revenue than forecast. So basically what we've done is we reduced the cycle time, and by our estimates, it happened a lot faster than we had thought, which I think is good news from the standpoint of our operational efficiency. It did create some forecasting challenges. But probably $20 million to $25 million came from Q3 into Q2.

The other thing I think you should take a look at is the FX assumption. So around $9 million or so, Didier, I think was the number. So FX added about another $9 million. So between the cycle time improvements, the FX assumptions, and just the fact that the market continues -- we're getting our fair share of markets, where they're growing, I think those combination of those three facts, I think will help you bridge the difference between our guided growth and what actually occurred.

Okay. Just a real quick similar question on the margin side. Obviously a little bit of the margin in the quarter was the drop-through, but it looks like you probably did better than you were expecting on an absolute dollar basis on the SG&A, as well. Can you help me understand maybe what is going a little faster there than you anticipated?

I think on the SG&A front, we've got a couple of our programs inside the Agile Agilent, a little bit ahead of plan, and -- but Didier, I don't know if there's anything else.

Most of the impact was volume driven, and obviously the FX. But there was -- versus the initial guidance.

I will tell you, the field structure that we put in place last year really stabled down. I think it's delivering, helping us on the growth side, and also on the SG&A front, as a more efficient go-to-market channel.

Thank you.

Thank you. And our next question comes from the line of Isaac Ro of Goldman Sachs. Your line is now open.

I had a question on margins, as well. On the gross margin side, I was curious if we should expect maybe another wave of improvement, now that you have the ERP integration done. And on the op margin side, curious how satisfied you are with the sales force realignment, and whether or not there's still more synergies to be had there as well?

A couple comments here, then I'll bounce it over to Didier, in case he'd like to add a few things here. In terms of the sales force integration and go-to-market, we couldn't be happier. That was a major move we made last year, where we basically went from five sales forces into two sales forces, one focused on the analytical laboratory marketplace, and the other one focused on the regulated diagnostic marketplace.

At the time I remember sharing with you, we're making a big change here, and it could affect the top line in the short run. That didn't happen. And in fact, I submit that as we go out into 2016 and 2017, we're now putting more resources of specialization, academia, and biopharma, so I think you're going to see the changes paying off in terms of our longer-term growth. So we're really happy with both the fact that we've got it all behind us, it's settled down, and I think it's starting to pay off on the initial benefits that we envisioned when we created that structure.

Relative to gross margin, the ERP, just keep in mind that what we've been talking about is the financial systems, which really go into the SG&A line. So it really won't affect the gross margin. That being said, we do think we can do more on gross margins, as we move forward in 2016, into 2017. I'll talk a little about it more in detail next week as we go to New York.

But as you may know, on our initial 400 basis points of improvement, when I came on board, we said half would come through OpEx and other operational costs and others through growth, and the growth piece would be -- a lot would be driven by our ability to capture the gross margin improvements on increased volume. So we think we still have room to improve our material cost, and we think that we've got room to continue to bring down our logistics costs.

That's very helpful. Maybe just a follow-up, just to clarify on two topics, one on biopharma, and the other one on the comments you made around China. On biopharma, could you just compare the growth rates you're seeing in the QA/QC setting versus R&D, and then in China, just curious, how much of your improved outlook there is based on the visibility you have with government funding versus end markets that are more on the private industry side? Thank you.

I think that on the -- to your question, we're not seeing significant differences in growth rates across the segments you described in pharma. I do think if you go out a couple years down the road, I think we'd expect the growth rate in the biopharma piece to be higher than the small molecule, but that's not at all the case right now. As you heard earlier from Patrick, we expect that to continue through 2017.

We're getting more clarity about what's going on in China. I think there was a lot of concerns at one point in time on the private sector side of the business, but obviously as you know, Isaac, the government drives the market there to a large extent. And we're getting more clarity on what's happening in funding. So that's why we have increased confidence in our outlook for our business in China.

Got it, thanks so much. See you next week.

Our next question comes from the line of Derik de Bruin of Bank of America. Your line is now open.

Just wanted to clarify. Did I hear you correctly, that you said your initial flash for core growth guidance for FY17 was 4.5% at the midpoint?

Yes.

Okay. And so can you like flank that in terms of what you're thinking for the chemical and energy market there? I mean, just what you're expecting in terms of rebound? Could you help us frame that comment a little bit more, in terms of some of the puts and takes.

Sure, I'd be happy to. Sometimes you can use colorful language, it doesn't really give you the insight you need. Let me try to clarify here.

What we said was in this year, we thought our performance would be flat for the entire year. Well, in fact, it's going to be down. We probably think in the range of 2.5% for the year, for the entire year, and that is a change from our assumptions coming into this year, and that was the assumption being made at the time of our initial guidance, which makes our revenue results even much more -- we're really pleased with the results, given the fact that the chemical energy market has not developed the way we initially had thought.

That being said, in 2017, we actually think it will be improved, which means it won't be declining, and in fact, will probably be flat or maybe low single digits. And why do we believe that? If you look at how our business breaks down in that segment, we have often talked about the oil side, but 15% of our business historically has been in the exploration, another 35% has been in the refining.

The other half, which is by far the biggest, biggest individual segment is the chemical side, and they're benefiting by lower feedstock cost. They've got pent-up investment demands, and we're starting to see increased deal activity. So in fact, Patrick and I were talking about this, this morning, it reminds me of pharma a few years ago.

Basically, we're going to have two years of shrinking performance in this marketplace. A lot of pent-up demand, so long story short, our growth assumption for next year assumes low single digit chemical energy growth for the year. Again, we still believe we're searching for the bottom, so, and it's still early in the year of 2016. But that's our basic assumption for 2017, which is an improved environment. Not dramatic, but improved from what we've seen over the last 24 months.

Just as a quick follow-up on the chemicals comment. You're not worried that some of the activity between Dow and DuPont, and looks like there may be Monsanto and some of these other companies that are dancing around, are you worried that could stymie investment, if you're using the pharma analogy of combinations of those companies, is there some potential headwinds from the chemicals market?

Derik, that's a great question. We looked at this pretty closely when the announcement was first made, and although Dow and DuPont are very important customers to us, that particular deal activity really is immaterial to the total Company's performance. And we didn't necessarily see it as a sign of an acceleration of M&A, and consolidations going on in this space.

So of course, there would be some pause if we would see more than that, but we're not overly concerned about that. And I guess the beauty of this business has been just the broad-based nature of our customer base. So we're not overly dependent on any one single customer.

Thank you very much. I'll get back in the queue.

Thank you. And our next question comes from the line of Dan Arias of Citigroup. Your line is now open.

Mike, can you touch on Japan and things that you saw during the quarter in terms of trends, and maybe what you're looking for at this point on the year?

Yes. Dan, to answer that question, and if you know a little of my history, I spent five years in Japan, so I have always been a big supporter of Japan, in terms of the long-term view of the market, and I'd ask you to take a long-term view of the market in Japan. That was the only market that actually was down for us in the second quarter, and we are expecting continued subdued performance in Japan. So we're not expecting much in terms of improvement in the overall market environment in Japan.

We do think it could be a market which often will respond to new technologies, and innovative new products. So we do hope -- we do hold out hope that we could take some share, some of our new intros coming out in the second part of this year. But from an overall market perspective, we are expecting to remain subdued. And our internal forecasts are not based on any type of material improvement at all, in our performance in Japan.

Thanks for that color. And you teased some new product introductions in the back half, that should be meaningful to growth. I'm sure you don't want to give away any secrets. Could you sort of help us with what part of the business you're anticipating seeing the boost in 2017?

Thanks for the caveat on your question. So what we can point to with great confidence and clarity is the recent introduction we made at Analytica. What I would say to you, you will see broad-based introductions across the entire portfolio, and core growth is central to our business plan. As you know, when I came in last year, we spent a lot of time reorganizing our R&D structure, and also reallocating where we put money.

I think you're going to start to see some of that starting to pay off, as we go into the latter part of 2016. So we did want to put a teaser out there, and also just to make sure you had confidence, in terms of what's behind our view of improved Agilent performance in 2017, off of the second half of this year. But I think you can expect to see us talking about activities across all three business groups.

Got it. Okay. Thanks very much.

Thank you. And our next question comes from the line of Doug Schenkel of Cowen and Company. Your line is now open.

Mike, I want to go back to some of the comments you made, on efforts to tighten cycle times from order to revenue, which seemed to be yielding benefits sooner than expected, particularly in China. Can you provide a bit more background on this effort, and why it was most impactful in China? And then maybe talk about similar efforts under way in other geographies? And relatedly, you positioned these, in answering some questions, as if they were temporary. At least it seems like your guidance doesn't treat these as sustainable improvements, yet everything else you said suggests that these are truly sustainable improvements. So I was just hoping you could help us understand that a little bit better.

Sure, Doug. I really appreciate the question. Maybe let me start with the last part of your question, which is the take-away here, we do believe there is sustainable improvement. In my mind, or the language I use, this is the new normal, in terms of our ability to convert orders to revenue.

And so I would characterize this as new normal of how we're going to operate. So how do we get here, and why did it look so significantly different in China? So first of all, it starts with looking at the entire process from an end-to-end customer perspective, from the time of order placement until shipment until customer installation occurs.

And as you know, when I restructured the Company I was really trying to break down the silos. We had a very silo-oriented approach to this end-to-end process from a customer perspective. In the Company, we looked at each slice of the process, but nobody was looking at the collective process end-to-end. You start doing that, then you start seeing where the issues are, the opportunities are.

So we found ways to improve our order linearity. We've improved the quality of booked orders, and this really gets to your question about China. Often you're dealing with letters of credit issues, and other trade issues that in the past have delayed our ability to actually book them as clean orders and turn them into revenue. We call these delivery box. We've been working on making sure we had material availability.

I think we hit one of our best quarters ever, in terms of having material ready for all of our shipments, so we improved our ability to get in orders in a linear fashion, make sure those orders are clean, and not have a lot of rework, and then we have improved our delivery performance and then spent a lot of time improving our efforts between shipment and installation, which sometime can go on for several weeks. I think it all starts at looking at the whole process from an end-to-end perspective, and the result has been a significant improvement in cycle time, and orders turned into revenue more quickly than in the past.

I do think this represents our new way of operating. And again, as I mentioned in my remarks, it did create some -- it did have implications of how we guide the Company for the second and third quarter, but I think we're delighted to be able to actually have ongoing strong operational efficiency improvements in place, so that we know how to predict the revenue even better in the future.

Okay. That's really helpful, Mike. But just to be really clear, recognizing these are well-learned sustainable improvements, it's not apparent that this is fully -- these improvements, the sustainability is fully reflected in guidance? If that's the case, is that just because you want to see this play out for a couple of quarters before you start baking it in?

I think the confusion might be that what we have stated is that this quarter in Q2 we got $20 million to $25 million of revenue that we had anticipated to be recognized in Q3, as we were bringing all those programs to fruition, we had earlier results, which is great. From where we are now, the order to revenue cycle time is sustainable, but we will not see further improvements that will bring Q4 revenue into Q3 or whatever it is. So the $20 million to $25 million, that's one-time. We've got to the level we wanted to be at, and from now on, it's just business as usual without any fundamental change in the order to revenue cycle time.

All right. Thanks for that, Didier. Just one last one for you. On the change in Lasergen accounting, was there any dilution in the quarter, and based on the accounting change, should we no longer expect this to be a $0.02 to $0.03 dilutive deal for the year?

Correct. You're correct. So there was no dilution in Q2, and there will not be any dilution for the rest of 2016 or 2017, until we exercise our call option, and then we will just fully consolidate. if we do that, obviously, fully consolidate the Lasergen revenues. So that's a change that there was a lot of -- I mean, discussions with the auditors, they surprised us a little bit by going to nationals to get specialist challenge the accounting that we had anticipated locally among the two teams, and then we agreed to the recommendation. And, therefore, no dilution to EPS coming from Lasergen in the next two years.

We were pleased we were able to get this closed off before we finished the quarter.

Okay. Great. Thanks.

Thank you. And our next question comes from the line of Miroslava Minkova of Stifel. Your line is now open.

Congratulations. On the quarter. Maybe if I could focus on operating margins again for a second. Just help us, remind us, there's a lot going on there, in terms of the programs you have in place and improvements you have going on. Help us, remind us, the bridge between FY16 and FY17, what gets you to the 22% operating margin?

Well, as a teaser we're going to go through this in some detail next week.

There will be a slide on the topic next week.

But what I can share with you conceptually is that we will be continuing and completing off the integration of the Dako acquisition. We have a series of operational programs. We talked about one of those already, which is the implications of the ERP. And the continued focus on gross margin improvements, specifically material cost reductions and logistics savings. I think the combination of those three factors, plus with the overall core growth assumptions that we're currently modeling around 4.5% gets us to the 22%.

Okay. Great. And the strength in the food market, was this all China, or are you seeing strength elsewhere as well?

Actually, it was both in food -- excuse me, the food market both in China and the United States. As you may recall from our Q1 announcement, this business tends to be a little lumpy, whereas I think the performance in the food market in China has been sustained. But we saw a nice rebound in the US in the second quarter.

Got you. Okay. And maybe finally, give us your view of the M&A pipeline. We've seen you do a couple of deals just recently here. Now that you have many of the operational initiatives for the new Agilent in place, should we expect that you're more active with the tuck-ins going forward?

Again, this is a teaser number two, which is we will talk about this a little more in detail next week. I do feel that the Company's foundation is really firmly established, and as I mentioned earlier, I think we're getting a lot better in terms of our speed to be able to integrate. What I think you can expect us to do is still remain disciplined and focused in terms of finding those opportunities that make sense for us, and I would ask you to think about us being complementary M&A in nature. We're going to continue to look for those. So our balance sheet is a huge asset for our shareholders, and one which we like to deploy relative to M&A, but it has to be the right target.

Okay. Thank you very much.

Thank you. And our next question comes from the line of Steve Beuchaw of Morgan Stanley. Your line is now open.

Good afternoon. Thanks for taking the questions. Just two clarifications on how you're thinking about the 2016, 2017 progression. The first is actually on the NIH.

To what extent, if any, are you anticipating a pickup in the research channel from NIH funding, when we start to see that get disbursed in the second half of the year? And then second, this may be even a longer term question, but how do you think about the evolution of FSMA regulations in the food space in the US? Is it too soon to start getting incrementally optimistic about how they could contribute to the outlook? Thanks.

Thanks. Glad to address both of your questions. On the NIH front, I think when we talked about the uptick and our improved confidence about the spends in academia and government in the US, I think we do think that the NIH stuff will start to flow through to our business.

Relative to some in our space, we don't have as high a percentage of our business tied to the NIH, but it will be a positive for us. And I think, again, one more fact pattern, which points to continued view that this market will be solid for us as we move into 2017. I think I'd have to agree with the comment, which is, I think it really is too soon to get overly excited about this from a US spending. I've seen this before, where the legislation is announced, and there's a lot of fanfare about it, but we don't always see it backed up by investments.

We are seeing some -- looks like some maybe more friendly governmental allocations to this agency, unlike we've seen to the EPA. So we're not expecting anything dramatic to occur differently in the market, because of this. But if it would, that would be clearly good news for us.

Thanks for all the perspective, Mike.

Thank you. Our next question comes from the line of Jeff Elliott of Robert W. Baird. Your line is now open.

Thanks for the question. Mike, on the margins, overall a really good quarter. Then when you look at the margins in DGG and CrossLab, basically flat year-over-year. I guess, is that what you were expecting? Anything that you could call out in the quarter? I know there's some moving pieces in that top line.

Why don't you take this one, Didier?

It's a great question and the answer is yes, it's precisely what we had expected. One of the obviously, from one quarter to the next, there could be some one time add-ins that adds a little bit of volatility. For example, last year both ACG and DGG had very favorable hedging gains, which have gone away, for the whole Company, the hedging gain last year in Q2 was over $7 million, and this Q2 was about $1.5 million, something like that. So it was mostly in ACG and DDG. They are were other one time items including regarding the allocation of our shared services among the different businesses, which explain. But both businesses are on their way to contribute to the operating margin expansion, and the 22% that we're committing to.

Didier, maybe I'd also ask Mark too. We talked about this earlier this -- last week as well about the operational efficiency improvements that underlying what looks to be flat margins. Peel back the onion, the hedging gains and other things, there's actually real operational stuff going on there.

Thanks, Mike and Didier. As Didier had said, there were several things that were factored in last year, that didn't come into play this year. We're working on a lot of things in terms of improvements. The mix is somewhat favorable in the context of what we're selling. But overall, when we look at our plans for the first half, we're up 70 basis points in the first half over last year. So our ability to actually do the margin improvements, when you pull back and look at in the first half, regardless of all these things, is quite positive.

And it's our fastest-growing business, he's been picking up more of the corporate costs of shared services.

Thanks, guys.

Hope that was helpful.

Yes. It was. Thanks.

Thank you. And our final question comes from the line of Dane Leone of BTIG. Your line is now open.

Just had a quick clarification from earlier. So you were talking about the replacement cycle in biopharma and quoted 150,000 LC systems, based on the 1100, 1200 platform. Can you clarify if that's what you think the opportunity is ahead of you, or that's the opportunity in progress? And if so, what -- how far are you into that?

This is Patrick. Let me answer these questions. First and foremost, this is not biopharma at all. This is pharma and biopharma combined.

When I talk about 150,000 systems out there, it's the installed base of LC systems in all markets. So it's not only in pharma, biopharma. But we think the biggest push is actually right now coming from pharma and biopharma. And I would still say we are in the midst of a replacement cycle.

We don't see that to be over in the next couple of quarters. There's healthy demand, and we are in negotiation with a lot of our core customers on upcoming replacements, and how we place these systems, and how we plan it out for them, so it works for them.

Dane, if I could add one other comment to Patrick's response. We've been focused a lot in today's call on pharma, biopharma but keep in mind that the replacement cycle has been very, very subdued on the applied markets side, in liquid chromatography, so we have several -- we have tens of thousands of systems on that side of the house, as well. Again, this is why we look out into 2017 and 2018, we think that our growth rates are sustainable.

Any way you could handicap, using a baseball analogy or something like that, what inning you think you're in?

Don't ask a German about a baseball analogy.

I'd say on the pharma side, you're probably inning five or six. Two thirds of the way through, maybe two-thirds. My point would be that I think the ballgame is just getting started. We may be in the first inning, we hope to be in the first inning soon of that cycle, on the applied market side.

Thank you very much.

Thank you. And I'm showing no further he questions at this time. I'd now like to turn the conference back to Alicia Rodriguez for closing remarks.

Thank you, everybody. And I'd like to thank you all for joining us today on the call. If you have any questions, of course, please give us a call in IR, and just would hope that we'll see you next week at our analyst day in New York City. Thanks again. Bye-bye.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.