安捷倫 (A) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2016 Agilent Technologies earnings conference call.

(Operator Instructions)

As a reminder, today's program is being recorded.

I would now like to introduce your host for today's program, Alicia Rodriguez, Vice President of Investor Relations. Please go ahead.

Thank you, Jonathan, and welcome, everyone, to Agilent's third-quarter conference call for FY16.

With me are Mike McMullen, Agilent's President and CEO, and Didier Hirsch, Agilent 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 will 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. 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. Please note that we are reporting results for the Americas, Europe and Asia on a ship-to basis.

Previously, we assigned revenue to these regions based on where the order was placed. This change aligns with individual country reporting, which has always been on a ship-to basis. Historical statements are available on the investor relations website.

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.

Now let me turn the call over to Mike.

Thanks, Alicia. And hello, everyone. Thank you for joining us on today's call.

I'm pleased to report that the Agilent team delivered another quarter above expectations. Let me highlight three key results.

First, Q3 core revenue growth of 3% was above the high end of our May guidance. Second, EPS of $0.49 was also above the high end of our guidance of $0.45 to $0.47. Finally, we delivered adjusted operating margin of 20.6%, an increase of 70 basis points from a year ago.

As for the third quarter results echo many of the same themes that we saw last quarter. The pharma, food, clinical and diagnostics end markets remains strong. In the chemical and engineering market, while demand for our services and consumables was strong, capital expenditures for new equipment purchases remain challenged. Geographically, Asia, led by China's double-digit growth, drove Agilent third-quarter core growth with strength across all business segments.

Let me highlight our Q3 results by business group. In line with our expectations, life science and applied market group core revenues were down 2%. Our strong growth in pharma, environmental and food markets, was offset by continued weakness in chemical and engineering capital expenditures. Academia and government revenues were also down across most regions. Despite this mixed market environment, LSAG's operating margin for the quarter was 19.1%, up 40 basis points from a year ago.

Let me shift degrees and talk about some of LSAG's new products. We're seeing very strong demand for the newly released 1260 and the 1290 Infinity II LC Systems. The 1260 systems were part of the launch of the Infinity Lab portfolio at Analytica in May. The Infinity Lab portfolio consists of this new line of LC instruments along with columns, supplies and services.

In Q3, LSAG also introduced the new, two new 7000 Series Triple Quad GCMS analyzers, one for pesticides and another for environmental pollutants. And we continue to strengthen our ICPMS market leadership with a new Agilent 8900 Triple Quad ICPMS System. This new system offers customers improved speed and accuracy of analysis.

Turning to the Agilent CrossLab Group, the business delivered another strong quarter with 8% core revenue growth. This growth is driven by strength in the food, pharma and environmental markets. ACG's operating market for the quarter was 22.7%, up 10 basis points from a year ago. Portfolio expansion efforts also continued in ACG. In Q3, Agilent signed a definitive agreement to acquire the assets of iLab and we just closed the transaction in early August.

iLab is the market leading in cloud-based solutions for core laboratory management and provides services to leading universities, research hospitals and independent institutions around the world. This acquisition further expands Agilent's portfolio in the academia and government market. iLab enables Agilent to deliver broader value for our customers in this market segment. We also see an opportunity to expand the iLab business both geographically and into the pharma market.

Finally, we saw continued momentum in the diagnostics and genomics group, where the business delivered 8% core growth in Q3. We saw strength across all DGG businesses, driven by growth in the pharma and clinical and diagnostics market. Our pathology business continues on a steady trajectory of improved growth. This was highlighted by demand for our new PD-L1 Companion Diagnostics. Growth in genomics reflect a strong market performance in the US and China across our Array CGH, target enrichment and SureSelect products. We also saw healthy demand for our nucleic acid solutions offering.

DGG's operating margin for the quarter was 18.8% up 200 basis points from a year ago. Q3 highlights for DGG include the announcement of an expansion of intended use of our PD-L1 pharma DX test in Europe for patients with melanoma. This test was previously approved in the US and available in Europe for patients for none with non-squamous, non-small-cell lung cancer, and in the US for patients with melanoma.

We also announced a $120 million investment over the next three years to expand production capacity for our nucleic acid solutions business. This includes the purchase of 20 acres of land in Colorado. We plan to build a factory on this land that will double our manufacturing capacity for nucleic acid active pharmaceutical ingredients and grow our business.

Now I'll provide an overview of Agilent's core revenues by end market. In our life sciences market, pharma saw its 6th consecutive quarter of double-digit growth, with core revenue up 10%. Academia and government core revenues were down 5%, down across most geographies except China. Clinical and diagnostics grew 4% with strength in North America and Asia and led by growth in pathology.

Applied end market performance was mixed. Food was up 11% with strong demand in China and the Americas. These regions also drove growth in the environmental market for both instruments and after-market products. This performance was offset by a continued challenges in the chemical and energy market, down 4% globally with only Asia posting growth on a regional basis. The overall result was due to prolonged effects of the macroeconomic concerns and lower oil prices.

Now I'll turn to an update on our operating margin improvement initiatives. Q3 marked a major step forward in simplifying our Company's infrastructure. In May, we completed the migration of the Company's financial systems onto a single SAP platform. This was a culmination of a 20-month cross-company effort and represents a major step in simplifying Agilent's systems infrastructure that would development incremental cost savings as planned in FY17.

In summary, our multi-year Agile Agilent Program continues to simplify the Company's business processes. This program is designed to make us more nimble and lower our cost. It will continue to deliver incremental savings in 2017.

On the capital deployment front, we purchased iLab, paid $37 million in dividends, and repurchased $94 million of Agilent stock. We continue to deliver on our strategy to drive sustainable growth, while expanding operating margins and balancing deployment of our capital to drive shareholder value creation.

At our recent May analysts meeting, I described our shareholder value creation model: outgrow the market, expand operating margins, balance capital deployment. Let's look at our Q3 results in the context of these longer-term goals and shareholder value creation model.

In 2015, we delivered our highest annual growth rate in four years, while increasing adjusted operating margin 170 basis points and completely offsetting the $40 million of disynergies from the Company's split. We have sustained this trajectory of improved operating rules in FY16.

In the first three quarters of 2016, the team has delivered strong growth and earnings above our initial expectation despite a challenging chemical and energy market environment and global macroeconomic concerns. We have continued to leverage our balance sheet and deploy capital in a balanced matter, buying companies that bring new capabilities to Agilent while repurchasing our stock and increasing cash dividends.

The new leadership team continues to transform the business and deliver rules. We continue to demonstrate our ability to deliver above industry organic growth while expanding margins and leveraging our balance sheet strength. Our Q3 results in a challenging global economic environment reflect the strength of our team, combined with Agilent's scale and broad differentiated portfolio of products and services.

Looking at today's overall market environment, we expect continued strength in pharma along with growth in the food, environmental and clinical research and diagnostics markets and in China on a regional basis. As I highlighted in our last call, we are experiencing a steeper and more prolonged slowdown in the chemical and energy market than initially projected entering FY16. We've subsequently revised our forecast for this market segment last quarter to overall low single-digit market declines for the year.

While there are some signs of an impending bottom in the market, we remain cautious in our outlook and expect Q4 to be in a similar range as the past quarter. Against this market drop, we are well positioned to capture growth in these end market segments and geographies where growth is expected to remain strong. The combination of our expanding our customer channel reach and continual strengthening of our portfolio positions us well to achieve our previously-raised full-year guidance of 2016 and our longer-term goals.

Our One Agilent team continues to work well together and is energized to win in the market. Overall, we remain on track with our 2017 goal to outgrow the market and improve our operating margin to 22%.

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 remainder of 2016. Didier?

Thank you, Mike, and hello, everyone.

As mentioned by Mike, we delivered higher core revenue growth, operating margin and earnings per share than the high end of our guidance. Earnings per share grew 11% in the quarter versus a year ago. We also generated $194 million in operating cash flow, more than double last year's amount, which gives us increased confidence that we will achieve our previously-raised operating cash flow guidance for the full year.

FX had a negative impact on revenue of about $10 million, or 1% versus previous guidance, and $7 million, or 0.7% versus last year. It had negative impact on operating profit of $3 million versus previous guidance and $1 million versus last year.

I'll now turn to the guidance for our fourth quarter. We expect Q4 revenues of $1.05 billion to $1.07 billion and earnings per share of $0.50 to $0.52. At midpoint, revenue is expected to grow 1.2% on a core basis. Versus previous guidance, FX is estimated to have a negative impact of $9 million on revenue and $2 million on operating profit. Our 21.3% adjusted operating margin at midpoint will be up 70 basis points sequentially.

Now, to the guidance for FY16. The Q4 guidance results in the following fiscal year guidance: At midpoint, revenue is projected to grow 4.5% on a core basis. No change from the previous guidance. Our earnings per share guidance of $1.90 at midpoint is also unchanged from previous guidance and corresponds to a 9% year-over-year increase.

Adjusted operating margin for the year is expected to be 20.4 basis points, or 80 basis points higher than in FY15. And finally, FX is estimated to have a negative impact on a year-over-year basis of $68 million on revenue, $10 million on operating profit related to currency translation, and an additional $21 million related to currency hedging.

With that, I'll turn it over to Alicia for the Q&A.

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

Certainly.

(Operator Instructions)

First question comes from the line of Brandon Couillard from Jefferies. Your question, please.

Go ahead, Brandon.

Brandon, you might have your phone on mute. Should we go ahead to the next question?

Yes, please.

Thank you. Our next question comes from the line of Steve Beuchaw from Morgan Stanley. Your question, please.

Hello. Good afternoon, everyone, and thanks for the time here. I want to start with the one regional trend that seems to be on many people's minds, which is what is going on in Europe. I wonder if you could speak to the trends that you saw in Europe over the course of the quarter.

And to some extent, it is a macro question, to some extent, it is research question. And of course, there is their UK referendum that's still out there. So I apologize for the nebulous nature of it all. But any color on how Europe progressed over the course of the quarter would be really helpful. Thank you.

Yes, sure. I'd be glad to provide some insider there and then I'm going to actually have Patrick jump in on this conversation as well, I think, given your recent travels in the region. But what we saw in the quarter was, obviously, a lot of macro events. The Brexit, Turkey, there was a number of developed in the quarter. We did not see any material impact from those events in our performance in the third quarter.

What I will say, though, it is raising an increased level of uncertainty amongst our customers in Europe and we've seen questions around when will budgets be released. So it is more of an uncertainty of question right now. There are people who are just sort of waiting to see how it is going to develop. Again, no material effect on the third-quarter results.

But as we thought about our guidance for the fourth quarter, obviously this influenced us to think about how will Europe develop through the quarter and, Patrick, I know you and I had a pretty deep conversation about this yesterday, so any additional thoughts you would like to add?

Yes. Thanks, Mike. Talking to our field, local [feeder] in Europe, you'll certainly get the feedback there, is some uncertainty, as you said. The Brexit had, with some of the government interviews, those deals had probably some minor impacts.

I think what is concerning us here a little bit is also there are a couple of other countries standing on the side lines and have other referendums this year. So we are cautious right now looking at Europe and the growth in our [end for] Europe for the remainder of the year and also going into FY17.

Thanks, Patrick.

Thanks so much for all that color. And then one bigger-picture question, Mike. You made a pretty significant investment with a pretty long horizon, long-term horizon on this facility in Colorado. So it speaks to your confidence in the long-term outlook for and the scale of the opportunity there.

Can you just talk us through how you frame the opportunity, remind us how big that business is today, and how you think about the medium-term drivers that you're investing in the pursuit of? Thanks so much.

Great. So I'm going to handle -- you're quite welcome -- I'm going to handle the first part of this question and then I'm going to turn it over to Jacob and he'll reassure you about the long-term growth potential which is the reason why I supported the investment. But just as a reminder, I think this is roughly about 5% or so of EGG's overall revenues in the range of maybe $60 million plus or so.

We still have capacity at the current site, but we've got a more demand that we can handle in terms of long-term outlook from our customers. So we can't bring on this capacity fast enough to satisfy the customer demand. We think this will be a bigger part of our growth story as we talk to you about 2017 and 2018.

And I think, as you'll hear from Jacob, there is a high degree of confidence that the business is going to be there and perhaps you can provide a little context of what exactly is this business, and why we are so confident that the market is going to be there for us.

Yes. Let me try to provide more color there. So first of all, a reminder that the nucleic acid solution division business out in Boulder is providing [all-to-go] APIs that constitute a new kind of drugs with a significant potential. These drugs are primarily, right now, opportunities within orphan genetic diseases that, today, there is no treatment and have devastating outcomes and these drugs have actually the opportunity to change the expectancy of, you could say, the survival and also the quality of life for such patients.

We are working with the leaders in pharma within these new types of drugs and Agilent is chosen again and again due to our deep technical experience to optimize all-to-gos for performance and consistency combined with our ability to scale in DMP. We have seen a significant demand accelerated over the last few years and, as Mike mentioned, we're currently expanding our current site to actually take up double capacity.

But we also see that that will run out. That opportunity is really limited and we'll run out in a few years from now. And thereby, the new investment in the new site will allow us to fairly double our capacity and even double again if you choose to do so.

We have decided, and based on a deep dive into the strategy and so on, to place the site in close proximity to the other Boulder site, at approximately 20 minutes' drive away so we can really leverage critical mass the highly experienced staff that we already have and capabilities and processes.

The overall market is in the hundreds of million dollar business right now and it is growing, something between 20% to 30%. However, when you commercialize drugs, when you get the commercialized drugs, this might be a significant step-ups, but we see lot of demand right now just in the clinical trial studies.

Thanks so much, everyone.

Thank you. Our next question comes from the line of Jonathan Groberg from UBS. Your question, please.

Go ahead, Jonathan.

Hello, Mike. How are you doing? Thanks.

Doing just fine.

I know you have one more quarter to go here, but any initial thoughts on the puts and takes you're seeing or how we should be thinking about FY17?

Yes, Jonathan, I would be happy to share my thoughts here. In fact, I perhaps will build on some of the comments I made in my prepared remarks, but we are still seeing ourselves on the same path that we talked about just a month or so ago in New York. I guess actually it was two months ago now that I think about it, but our position remains the same. We're still confident that we're going to be able to achieve the overall projected core growth of 4.5%, and there really are some new factors that we think support this level of growth.

First of all, we have a rich pipeline of new product introductions coming in Q4 and in FY17 on top of what we've already introduced this year. Now, we think our customers are going to be really excited about what we're bringing to market and then that's going to help drive share, so we know we've got this NPI pipe going through the system right now, with releases coming up in the several quarters on top of what we've done.

The second thing, we also recognize the fact the Agilent business model has really changed a lot over the last 18 months or so. We have a lot more recurring revenue and if you look at the ACG and DGG business, which now represent over half, I think it is 52% last time I did the math, of Agilent's revenue, these are just inherently much more predictable revenue streams. And you saw in our Q3 results how both groups delivered high single-digit growth and they're not subject to the same types of issues we're seeing in the capital intensive chemical and energy market, for example.

And then the third thing, I would say, is when you think about our LSAG instrument business, in addition to the impact of these new product introductions I mentioned, we do expect that pharma in China market is going to remain significant growth drivers, although I think they will be below these double-digit ledges levels we've seen in 2016. And as mentioned in our last call, we still expect that the chemical and energy market will have bottomed by the end of calendar year 2017.

We're not ready to. Excuse me. Thanks, Didier, I got my years confused there. By the end of calendar year 2016. We're not ready to call bottom, but we do see in 2017 that we're forecasting that we could be in the low single-digits growth in a market which has had 18 to 24 months of pent-up demand for equipment that supports the production process.

So those are the three factors that have gone into our thinking as we have thought about 2017's growth rate. Obviously, we'll give you the official guidance at our next call, but I would just reinforce our view today is that we're still on track to what we told you in May in New York.

Great. That's helpful. Just one quick follow-up. On the capital equipment business, I know you mentioned going into the quarter last time when you gave guidance, you thought there had been a little bit of pull-forward and you highlighted why you thought it might be a little weaker. I'm just curious, was it in line with what you thought? Or was there anything unique in the quarter that maybe wasn't right along the lines of what you thought?

Absolutely. I think the quarter was actually in line and actually a little bit better than we had anticipated coming into the quarter. So no major surprises in our Q3 results. And, as you can imagine, we were delighted with the ability to deliver above our expectations, both top and bottom line.

Okay. Thanks.

Thanks, Jonathan.

Thank you. Our next question comes from the line of Jack Meehan from Barclays. Your question, please.

Hello, Jack.

Hello. I just wanted to ask about the LSAG business and some of the moving parts there. And could you maybe just talk about the chromatography markets? A couple of your peers have really had nice results there. Just what you're seeing there would be helpful.

Absolutely. Patrick, if you could break it out, obviously, between liquid chromatography and gas chromatography as well.

Absolutely. Happy to do so. As Mike mentioned earlier in his remarks, we did receive very strong growth right now in the liquid chromatography business, which has been, for the entire year, double-digits. And that is, from what we see, clearly also taking market share right now. We had a very strong launch of several waves of the Infinity series starting in 2009 and 2012 and now this year with the 1260 series with another big round of instrumentation and solutions in liquid chromatography that is very well received by the end markets.

Received very healthy replacement business as well and it is driven by the fact that these solutions are 100% backwards compatible and also compatible with some of our competitors' instrumentations, which makes method transfer very simple and seamless for our customers. And we project this cycle to continue for several more quarters. We don't see yet a lot of momentum. What we see, of course, is that we're getting now into quarters with tougher compare because we have seen double-digit growth from them for several quarters now.

On the gas chromatography side, again, very strong portfolio as well. The issue we're seeing there is that the core market or one of the big markets for gas chromatography is the energy space and that, of course, pulls some of our results down at this point in time. If the market comes back, we think we are in an exceptional position to pick up this pent up demand.

When the market comes back.

Yes, when the market comes back. Sorry. So I think we're in a great situation there as well. And we an outstanding product portfolio and ability to capture the growth when it comes back.

The reason I asked Patrick to segment his remarks in liquid chromatography and gas chromatography, we have an outsized exposure in gas chromatography, and when the, relative to the number two competitor in the space, we're at least 2X the number two person, and so when our major market is down, it really hits us. And that is why, again, we're really quite pleased to be able to deliver the growth we've done so far with our number two market actually being down below our initial expectations coming into this year.

Yes, that's really helpful and I appreciate all of the details in the different segments. If I could just follow up with one more. The Americas growth, negative 1% in the quarter. I know it is on a tougher comp relative to last year, but could you maybe just talk about the mix of the end markets there and whether there were any other notable changes worth pointing out? Thank you, guys.

I think the big one there is the chemical and energy market. It is down pretty sharply and I think that's bringing down the overall numbers as well as our academia and government business was down over last year. Although, we think, some of that, the way we're thinking about our plan for the rest of this year, we think the federal money will be there in the fourth quarter for us.

And in addition, if I might add, that we had a very strong quarter in Q3 last year in Americas. So it is a tough compare.

I'm not always willing to let my guys to do the tough compare argument, but thanks, Patrick.

Thank you. Our next question comes from the line of Tycho Peterson from JPMorgan. Your question, please.

Thanks. Maybe first on the academic trend, because it is a big swing from what you reported last quarter. I understand the Europe dynamic, but frankly, what we hear from you is a little bit different than we've heard from most of the other life science peers. So can you maybe just talk a little bit about why you felt more pressure in Europe academic than maybe most of your peers?

I'd point to two factors. I'm not sure exactly what all our peers are saying about Europe. I think they're probably saying the same thing, which are the European budgets are constrained and funding has not been released and it has actually been withheld in some situations. I also think you may be hearing a more positive spin on the US environment because of many of our competitors have much more business coming from NIH.

So there is a lot of positive view of the NIH budget, but we pick up a relatively small piece of that overall budget. The agencies where we do a lot of our business in the US government, we know the money is coming in the fourth quarter. Anything else you can add to that, Patrick?

Not a lot. As you said, although our competitors [definitely an other mixed bag], on average, I would say.

And then, similarly, environmental was flat after growing 6% last quarter. Can you maybe just comment on dynamics there?

I think the biggest dynamic there is there is a sub segment within environmental where we pick up our forensics business and we report externally just the total environmental business, but a lot of big deal activity in forensics. So last year, we had a lot of big deals at this point in time.

The only environmental market that is going to be a big deal is in the second quarter. So it is really a forensics-driven phenomena which is where we didn't have as many big deals in the third quarter and this business tends to be a little bit more lumpy than our base environmental business.

Okay. And last one. Little bit of an esoteric question. On the PD-L1 data sets in front line lung, can you maybe just talk about whether there is any change in your outlook? Obviously, [Bristol] attempted to go without a companion and failed. Merck is doing a companion. So can you maybe just talk about whether some of those developments have changed your view of the market opportunity overall?

Sure, Tycho. In fact, we just had a conversation on this yesterday. Jacob, why don't you share the latest thoughts from Agilent on this topic?

Yes, I will say, first and foremost, we're very pleased with the performance we've seen at PD-L1 over the last 10 months. And we continue to see strong traction. You're right, there has been some announcement recently on some studies that has not come out as expected.

It really supports our thesis about the importancy of CDX and really that you need to make sure you've stratified your patient group the right way. So clearly there is a short-term opportunity, at least from one of our customers, that is little less than we hoped for, but I don't think that that overall changes really the thesis and we continue to see a big opportunity here.

Okay. Thank you.

Thank you. Our next question comes from the line of Ross Muken from Evercore. Your question, please.

Good afternoon, guys. So it seems like most of the confusion we're hearing is sort of on the sequential progression of core revenues, and so I look at the last two years, and it looks like, sequentially, the comp is roughly, I don't know, 200 basis points easier on core. It looks like you have a little bit heavier of an NMR headwind in 4Q than you did in 3Q. So one, can you confirm that?

And then, two, as we just think about the crosswalk, what are the other sort of underlying assumptions in terms of what is different sequentially versus 3Q, whether it is end markets or any of the key segments? And then where have you built in, I guess, some conservatism or some of that uncertainty?

Thanks for the question, Ross, and why don't I go ahead and just share with some thoughts about the Q4 guidance and then, Didier, maybe you can dig through your notes on the NMR impact. I think it is important for me to share with the audience here today about how we thought about our Q4 guidance. And I think this may get to the root of some of your questions.

As you heard on the call, first of all, we're quite pleased with the higher-than-guided core revenue growth that we delivered for Q3 after having raised in last call, and I think we've got this increased confidence to achieve our previously raised core growth guidance for the year. And, listen, we realize by not raising our core guidance for this year, that this question could arise.

But the way we looked at it, we said, listen, there is a raised level of uncertainty in the market centered around Europe. And we saw some weak European government budgets in the third quarter. Is this going to continue? We have seen some downward revisions in terms of market overall economic forecast for Europe. So we're really not sure exactly how that's going to develop.

So we just thought it was prudent to reflect some of this uncertainty by not raising again the full-year guidance. That is how we thought about the process. We didn't really look over the years sequentially. We do know that last year, although I've said I don't like the tough compare argument, but we did have a blowout fourth quarter last year. But anything else, Didier, you can remember unusual -- ?

No. And NMR is not a factor.

NMR is not a factor. Okay.

You pointed out that really what we intended to do is maintain the overall core revenue growth for the whole year and that's how we derived Q4.

We had raised last quarter and the business is developing in the third quarter actually better than we had thought, as you saw in our results. And as we looked to the fourth quarter, we said, listen, we don't know how this Europe is going to play out, so let us just be cautious as opposed to raising again for the quarter.

That makes total sense to me, Mike. I think, given some the uncertainty, you certainly don't want to get in front of your skis and you guys have been beating numbers so that's good. I guess, as you think about the key product cycles for the business, how do you think about the cadence, now that you've had some releases of when we could start seeing that also draw up the core growth overall?

And then, secondarily, when do we start to comp through, we've now, I guess, comped through some easier compares on the diagnostics business, which has been going hot for, I don't know, four or six quarters now. How long do you think we've got left on that trajectory of sort of high single- to almost double-digit growth in that business?

I think there, for the foreseeable future, we're highly confident on the growth rates in this business and that's why I made the comment earlier about, hey, when you think about Agilent long-term growth perspective, you think about 2017, think about that we've got over half of our revenue in markets that are going to have a steady trajectory of growth. And you heard Jacob talk about what is going on in the companion diagnostic PD-L1.

That is why I wanted to highlight the investments that we're making in NASD, which is a part of the business we haven't really talked a lot about with you. So I think there is a lot of genomics, the SureSelect next gen sequencing, there's lot of fundamental, very attractive markets that we have a strong position in. So, Jacob, I don't want to necessarily speak for you, but I guess I have, that we expect that this growth rate will be sustained. Anything else you would add to my story?

You're absolutely right. And I'm definitely pleased with the excellent growth. Last quarter, we had 5%. So I really want to make sure you saw that we were, when we talked also at analysts day, we believed the right, the direction is [6 to 7]. I'm happy to beat that. But we do not see any change in trajectory right now and we'll continue in those high single-digit growth rates going forward.

Thanks.

Ross, I think perhaps your earlier question was around product cycle replace. Yes, so I think, as you may know, when I came into the role a little over a year and a half ago, we had really spent a lot of time redirecting our R&D programs. We restructured the Company, we reorganized our R&D programs. And I think you're starting to see the cadence.

So you've seen some of the products come out we highlighted earlier on the chromatography side, some updates, and new products around spectroscopy, ICP-MS, and we know that this cadence is going to continue throughout the next quarter and into 2017. So that is why, when I got the earlier question about, hey, what are you thinking about in terms of 2017?

I know what is in our road maps and I know what is coming into the market over the next 12 months and I know what has already come to the market and I know how customers are responding. That's why we have this level of confidence about our ability to continue to grow this Company in what has been verily mixed market conditions to say the least.

Great.

Thank you. Our next question comes from the line of Doug Schenkel from Cowen. Your question, please.

Hello, good afternoon.

Hello, Doug.

My first question, I guess both are going to be on guidance. So for fiscal Q4, your guidance essentially tells us that you're assuming operating margin declines year-over-year in fiscal Q4 in spite of what seems like could be a, I guess, mix-wise, a pretty favorable quarter year-over-year, based on your commentary. So, keeping that in mind and the fact that you've actually expanded operating margin year-over-year, I believe six straight quarters, can you just explain why this makes sense?

Yes. I think you've got the string of consecutive quarters, it has been six quarters in a row, and, Didier, we looked at this, I think it is purely volume related but --

Yes, absolutely. Same thing for operating margin as for revenue. Our approach is we wanted to maintain our full-year operating margin because obviously it is linked to revenue, so we maintain our core revenue growth assumption of 4.5% and our operating margin assumptions of 20.4%.

Now you are absolutely correct that that would mean that 50 basis points reduction from the significant operating margin we had in Q4 of last year of 21.5%, is still a significant 70 basis point sequential improvement and you have to take into account, as Mike said, that this is based on only 1.2% top-line growth. So, a slight reduction in operating margin, still very significant increase sequentially, but slight reduction related to the one, the assumption we made on the top-line growth of only 1.2%.

Right and if we can do better on the volume, we'll do better on the margin.

Yes.

I guess that is a segue to the second guidance question. I don't mean to be redundant here because there has been a lot of questions on this already, but I'm going to ask anyway. Your guidance is for around 1.2% core revenue growth in the quarter. If we think about this by end market, you actually have an easier compare in environmental forensics, academic government, and food relative to certainly what you had in fiscal Q3.

Diagnostics is a little tougher, but you have some real momentum there. So if we just kind of, to make it simple, assume all those end markets grow 3% to 5% and that chemical and energy is down mid singles, it would imply that you guys are thinking pharma is only going to grow low single-digits, maybe at best in Q4. It is a tough compare in pharma in the quarter. But you've talked about continued strength in pharma in FY17 in response to an earlier question.

Again, recognizing the uncertainty you talked about in Europe, I guess some of this is hard to reconcile. Can you help out a little bit? And, specifically again, what are you assuming for pharma in the quarter? Is that because of the compare? And what is your assumption for Europe for the quarter?

Yes, sure, glad to walk you through this, Doug. In fact, we spent a lot of time modeling our end market views for the rest of the year, anticipating that this might be a question that would arise. And as I recall, Didier, I think that we had a less optimistic view relative to academia and government than I think Doug's math was, where we were concerned about Europe. And we basically have it a flat, flat for the year, and I think we still have pharma around double-digits. So if you want to just maybe do a little walk-through.

Yes. Maybe, again, considering how we explain how we came up with the Q4 guidance, the makeup of the Q4 guidance by market is we are assuming that academia and government and chemical and energy will show the same core revenue growth reduction year-over-year as in Q3. So minus 5% for academia and government, minus 4% for chemical and energy. So the assumption is no change between Q3 and Q4. And then for the rest, pharma, you mentioned pharma, we are assuming mid single-digit, and again, on a very tough compare and to in line with the way we have been very conservative on the --

Yes, and just to be clear, my comment that was about double-digit pharma, that's for the for the full year.

And for the full year, yes. Double-digit, absolutely.

Yes, Doug, maybe just one other, as we thought about the Company coming in, I think we thought that the pharma growth would be lower. We thought China would be lower and we thought chemical and energy would be higher. And in fact what's happened is pharma has actually been stronger in China and stronger than initially forecast and you know the story on chemical and energy.

Okay. The only thing I don't think we got there, and maybe I missed it, but what is the assumption for Europe in the quarter?

It's about -- that is down low single-digits, mostly on the basis of chemical and energy.

And the academia and government.

And academia and government, yes.

Okay. All right. We'll take the rest off-line. Thank you.

All right. Thanks, Doug.

Thanks, Doug.

Thank you. Our next question comes from the line of Tim Evans from Wells Fargo Securities. Your question, please.

Hello. This one is for Didier. It seems like cash flow is something that's going better than expectations, or better than our expectations at least. I wondered if you could talk a little bit about the remaining levers that you have to pull on that as you go into 2017. Do you think that free cash flow growth in 2017 is really just going to be a matter of earnings growth or is there more that you can do there to improve free cash flow faster than earnings?

Yes, there is more that we can do. Certainly, the profit before tax is going to be a factor, but Henrik, who heads our order fulfillment and the supply chain organization, has also committed to a material decrease in inventories.

He's here in the room to hear that directly.

So that is also something that we're counting on that will help us continue expanding our operating cash flow as a percentage of revenue or percentage of profits.

Okay. And then a quick one, going back to one of Tycho's questions on the forensics end market. Of that 12% slice of pie that's environmental and forensics, would you be willing to tell us how much is forensics?

I don't think we can disclose that. It is fairly small, but enough to move it periodically when big deals happen.

Okay. Thank you.

Thank you. Our next question comes from the line of Isaac Ro from Goldman-Sachs. Your question, please.

Thanks. I just had a question on margins and then a follow-up on Europe. On the margin side, thanks. On the margin side, if I look at sort of the components of gross margin, it is interesting, the LSAG division is your highest gross margin segment in most quarters. But that was the one where you saw a little pressure. So, can you help us think a little bit about the key initiatives you guys have under the hood there to continue to driving better gross margin versus expectations? And same goes for SG&A.

The question was what are the initiatives we have? I just want to make sure I understood the question.

Yes, over the last 12 or 18 months, you guys have talked a lot about some of the things you're doing to drive gross margin higher. This particular quarter, you had a little weakness in your most profitable segment. So I'm wondering, aside from just the top-line contribution, what you guys were able to achieve this quarter on the gross margin line that allowed you to put up a slightly better result.

Great. Great. Thanks for the question. What we have been focusing on are really three dimensions around what we call our value engineering program, our logistics model, and also our strategic procurement approach with our suppliers. And as I look at the results in 2016, the program that Henrik is driving across the Company, I think we have probably have seen the biggest impact so far in our improved logistics model, and you may recall, we talked about logistics costs as being problematic in 2015. That's no longer the case. In fact, we've benchmarked ourselves and we've got ourselves down to the best of the best in our space.

And then there is actually is more to come, which is the other two elements of the program have a little bit more longer tail in terms of payoff, which is value engineering, when you're re-engineering product platforms to ensure both a continuation of the high performance, but at a lower cost. And then as we also continue to transform our supplier engagement model and how we leverage the scale of that, and so I think those latter two parts of the program are going to carry us forward into 2017 and 2018 and beyond. I think that is how we're really working the gross margin side.

And by the way, I noticed all your comments were focused on LSAG. A lot of logistics costs and some of these other factors I mentioned, procurement, show up as impacts on the DDG and ACG business as well.

And then relative to the SG&A, a couple of things that you may recall I highlighted in New York, and I just reemphasize again, major focus on our systems infrastructure. So as you heard in my prepared remarks, we are now on one SAP instance, simplifying a lot of our work for our financial team and taking a lot of cost out of the system. The next big wave will be when we move the former Dako company into the Agilent environment in 2016 where we can really start to leverage the scale and take out costs and have an improved customer experience there.

So there is a couple big initiatives as well as we're looking at other aspects of our benefit structures. We have made some changes, you may know, earlier, to our US pension plan, and the Agile Agilent Program I mentioned is alive and we have lot of initiatives under way to ensure that we can continue to take cost out by simplifying the Company. Didier, anything else you would add to that?

I would mention the currency hedging. It had a big impact, it will have a big impact on a year-over-year basis. It is all impacts to gross margin, and ACG and DGG, because of their footprint, have been more penalized.

So ACG on the year-over-year basis lost $6 million on gross margin just because of the hedging programs, and DGG $2 million. That also explains the difference between ACG, DGG and LSAG. LSAG has a different footprint, obviously, with a stronger presence in Europe, for example. And so that can distort a little bit the percentages.

Thanks, Didier.

That is helpful. Thank you. Just to follow up on Europe. I want to make sure if I understand how what you are seeing maps back to the guidance and so two items there.

One is did the weakness in Europe, did that pick up in the month of July, just given you guys were off calendar versus the peer group? And secondly, does your guidance assume that the academic end market in Europe weakens further as the year progresses or that it sort of stabilizes from here?

So, nothing unusual in July. And I think the assumption for the Q4 is basically a continuation, not any worse, but not any better. And we just thought that was a prudent way to think about the Company's performance for the fourth quarter. I would love to be wrong, and I hope I'm wrong, but we thought, from a planning and guidance standpoint, we should be prudent in terms of how we looked at the European market overall.

Okay. Got it. Thank you, guys.

Thank you. Our next question comes from the line of Derik de Bruin from Bank of America. Your question, please.

Hello. Good afternoon.

Hello, Derik. How are you doing?

I'm well, sir. Thank you. So a lot of the revenue questions have been asked and, I mean, it certainly seems prudent to me, your guidance just given that Europe, even in a good year, the calendar third quarter is always a little bit choppy anyway, so there's clearly some heightened uncertainty this year, so I think it is prudent to be a little bit conservative. But could you just talk a little bit about some of the -- I noticed the share count was a little bit higher this quarter than what you previously guided to. You still looking at buying back 1% of the outstanding shares and sort of going into, going forward?

Yes. Why don't you talk a little about our share repurchase activity in the quarter and how we're thinking about it going forward, Didier?

We filed it back in, now what, November 20, I think, of last year. A 10b5-1 on an annual basis and we intend to file a new one, to register a new one also in November of this year. And it is a formula-based instructions that we have provided between buying 350,000 shares a day under certain conditions to buying zero kind of thing with a cap as you can imagine.

We don't know exactly how it's going to play out in Q4, and the only thing that we know is that, if there is any kind of shortfall at all in our intended buying in Q4 because of the formula in the 10b5-1, it will all be carried over into the following year. So do we intend to spend exactly what we committed to spend.

Great. That is really helpful. Could you just give us a metric on what instruments versus consumable growth was in the quarter as an overall number for the Company?

I think probably the best way to think about it, just look at the respective business groups. You had the LSAG results of down 2%, and then the--

ACG up 8%, and DGG up 8% also.

Got it.

Minus 2%, plus 8%. And that's why I, again, as you think about 2017 for the Company, if you really want to look at the growth rates of those two business units in the recurring revenue space, ACG and DGG, perhaps differently than you might think about how you model the risk profile for revenue projections for the instrument side of the Company.

Great. That's really helpful. And I guess could you, when you sort of, you're still feeling good about the margin target for 2017 and it sounds like that you're IT initiatives are well under way or finished to do like that. Do you still feel confident about getting what you're expecting for next year for the margin improvement?

Absolutely. That is why I made a few comments about that earlier, because, as we said, if we can be in that 4.5%, 5% kind of growth range, perhaps even [low 4%s], it makes it a bit more challenging, but we see the path to 22% is not just around margins, I mean, excuse me, not just around margin improvement from volume, but there are specific real programs. It's something we review once a month and we have active programs and the cost will continue to come out on some of these big programs.

Actually, I must say, I'm really pleased with the team because we've went through and did the, what we call, project [NUNU], is the finance program we just finished up. Right on the heels of that, we're going to go live in early 2017 with our integration of Dako. So the teams are still energized and working hard and I think these are going to have a material impact on our results in 2017 and that is why we have confidence about, assuming no major change in terms of the macro environment, that we can reach what we think are pretty challenging goals, but we have got a path to get there.

Great. Thank you very much.

Thank you. Our next question comes from the line of Dan Arias from Citigroup. Your question, please.

Afternoon. Thanks for the questions. Patrick, just going back to your comments on share gains in LC, I know you guys don't like to get too specific on winners and losers, but as was mentioned, it does look like all the major players are doing fairly well there. So, who would you say you're taking share from? Is it the small column providers or does that actually extend to some of the box companies as well? Thank you.

Well, thanks for the question. I can give you only a general flavor here on what we think is going on in the market. I will not comment on the individual competitors, but your assumption that the smaller suppliers probably take a larger hit is also our observation.

Okay. And then maybe a specific one on C&E. Mike, at the analysts day, you called out a Saudi Arabian refinery build-out that was getting going. Have you started to see some demand there and is that something that you think contributed at all to the back half of the year?

The major projects under way haven't been cancelled, but what we're not seeing there are any major new projects under way. There is a lot of positive news by a lot of studies about where this market's going, but we're not seeing, just to clarify here, the major projects that we knew about, whether it be the one I mentioned in Saudi, or there is a major project down in Texas, these programs, they're going to come on line.

So people aren't cancelling capacity increased projects, but we're not seeing a lot of new projects, and that's why we have taken a fairly conservative, pragmatic view of that marketplace. Again, I would like to reminder everybody, too, when we talk about chemical and energy, over 50% or so is actually chemicals, or chemical processing, not directly tied to the exploration and production of oil.

Got it. Okay. Thank you.

You're welcome.

Thank you. Our next question comes from the line of Paul Knight from Janney Montgomery Scott. Your question, please.

Hello, Mike. I guess, specifically, what is the GC business doing? What is its growth rate? What was it doing in the July quarter? And what is the backlog or what's August look like, I guess?

Well, thanks, Paul, I appreciate the question. And as you probably will understand, I'll give you a more high-level resolve because we don't actually comment specifically at a product category level, beyond I think I would just reemphasize the point that Patrick made when he characterized the chromatography market, that business is down relative to last year, because the chemical and energy market is down.

And we have seen no movement at all, downward pressure on our share position. It is really a market phenomenon we're dealing with right now and that's why, when that replacement market does turn, and we've been through these cycles before, when it does turn we will be in a strong position to capture that growth as given the strength of our position in that market, which right now happens to be down.

And then last, on the applied markets, in a broader sense, do you think it's still a GDP growth rate normalized or what do you think the applied markets should be for Agilent?

We actually don't think about it that way because the big segments of the market, like your food and environmental testing, we think, are independent, to some extent, of GDP. The only way I think that we really think about that as relative to it is our chemical and energy space. So if you could just kind of think about tying GDP to that sub segment of the Company, I think that would be a good place to start.

But I would not apply it to the whole of the core applied markets because these are being driven by quality of life investments in the food and environmental area and I think that's why -- I think that this composition of our end markets is the reason why we have been able to put up these kind of growth rates even when our number two market as a Company has shrunk this year.

And then last on, you had your analysts day, obviously. You've been talking about a 22% operating margin. Are you more or less confident in that number for FY17 at this juncture?

Yes, I think the confidence level is the same as it was back in May, and again, I'd maybe just share a few points here which are we have this confidence of delivery on that given our belief that we can get that growth rate, that we're putting up growth rates right now in that territory. We've got this pipeline of new products coming out. We've got this nice recurring revenue stream with ACG and DGG that will carry this momentum into 2017.

And that, where our instrument business is going? Pharma still looks good. Of course, you have these double-digit compare issues. China looks to continue to be strong. Chemical and energy has got to turn at some point in time because the market requires these tools to support production. Our thinking is, when we look at chemical and energy is, we know our customer is looking for productivity improvements to help improve their company profitability. We think that's a value proposition that Agilent has.

We think, as they go through their budget justification processes and their budgets start in calendar in 2017, that this is why we can say this and the decline in this business after 18 to 24 months will start to turn and we could see low single-digits by the end of 2017 for the chem and energy market. If that happens, which we believe it will, that will give us the confidence to get the growth and then we know we'll get the margin, given both the volume, but also in terms of gross margin improvement initiatives as well as our SG&A cost.

Okay. Thanks.

Thank you. And our final question today come from the line of Catherine Ramsey from Robert W. Baird. Your question, please.

Hello, guys. And thanks for the questions. We've heard a lot of commentary from your peers on Japan: strong pharma environment, weak academia and government. So I was wondering if you could walk through your exposure by end market there and what you're seeing across those customer groups.

Didier, do you remember the total Japan numbers I think were -- ?

About 5% of our overall (multiple speakers).

Just give you a sense of 5% of the total market. Historically, we have been stronger, and I can share this from my experience having been the country manager for Japan for a few years in the early part of my career, we tend to be much stronger in the chemical and energy segment of that marketplace.

We're doing well in the life science research and in genomics, but the majority of the business sits in the chemical and energy space, which has been down. I think Japan has been part of that story. Pharma, the pharma business for us is a relatively smaller portion of the market for us. I think they're doing well in pharma, but not enough to really drive significant overall growth rates for Japan.

Okay. Great. And then any color on the progress of the Dako integration, what is left to do there? Had some nice up margin expansion and DGG this quarter. So are you still thinking 20% in FY17, or could there be upside to that number?

Jacob happens to be sitting right next to me in this conference room. I don't think he's ready to sign up for more than 20% because it is quite an improvement from where we started, but I think he remains quite confident in the 20% achievement of that goal of an OM perspective. You saw, we had 18.8% operating margin this quarter, up 200 basis points over last year.

And the big next wave of integration efforts will really be starting in our Q1 2017. So we have a major program, we call it Project de Gaulle. We seem to like a lot of these French names, Didier. I'm not sure why that may be the case. But, and that really will be the next big step to move the former Dako company into the Agilent environment.

It will take a little bit of while to get the cost out, but as you think about exiting 2017, you are going to have a much lower SG&A spend than you started the year. And, Jacob, I don't think you'd share anything else.

No, I think you encapsulated very correctly. I just want to reinforce what you said that the path to 20%, of actually delivering 20% in 2017 is a significant turn around of where we were a few years ago. Right now, that is our full aim and I'm very happy where the team is in executing this right now.

Thanks, Jacob.

All right, great. Thank you.

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Alicia Rodriguez for any further remarks.

Thank you, Jonathan. And on behalf of the entire Management Team, I'd like to thank everybody for joining us today. If you have any questions, please give us a call at IR. Thanks, again. Bye bye.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.