安捷倫 (A) 2016 Q4 法說會逐字稿

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

(Operator Instructions)

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

Thank you Karen, and welcome everyone to Agilent's fourth-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 Thayson, 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. 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. And now let me turn the call over to Mike.

Thanks, Alicia. Hello, everyone. I'm very pleased to announce that our Agilent team ended 2016 with another strong quarter of excellent results.

I will start by looking at our key numbers from the quarter. First, we continued to deliver above market growth. Revenues of $1.1 billion exceeded the high end of the guidance by a sizable $41 million, and were up 6.3% on a core basis. We were the first surprised by the strength of our instrument business in pharma, China and Europe, which far exceeded our expectations.

Second, our adjusted EPS of $0.59 was $0.07 above the high end of our guidance. Finally, we continued our track record of improving profitability, as we delivered another quarter of operating margin expansion. Adjusted operating margin of 22.5% was up 60 basis points from Q4 of FY15.

Turning to our full-year results, core revenue continued to outperform the market, growing 5.9%. We increased operating margins 110 basis points to 20.7% from 2015.

These results drove a 14% increase in adjusted earnings per share for the full year. We are capping off the second year of our Company transformation with stellar performance by the Agilent team.

Our fourth quarter and full year results demonstrate our continued ability to win in the market. We are outgrowing the market while expanding margins and fully leveraging our strong balance sheet. In the past year we distributed $150 million in cash dividends, repurchased $434 million of our shares, and invested $480 million directly into the business through M&A, strategic transactions and transactions and capital expenditures.

Let me address what's happened in our end markets and business groups. I'll start with the end markets. Our Q4 trends were similar to what we experienced last quarter, with pharma and academia and government being the exceptions.

We had expected continued strength in pharma, but our 16% growth on a difficult compare exceeded our expectations. Growth is being driven by strong customer acceptance of our new products and enterprise service offerings.

Academia and government's decline of 2% was less than expected. European spending is holding up better than projected, while US government investments continue to lag 2015 spending levels. Clinical and diagnostics grew 8% over last year, led by continued growth in reagents.

Within our applied end markets food is up 10% with strong demand in China and the Americas. China also drove growth in environmental market up 3%.

Chemical energy declined 3%, in line with expectations, due to the continuing effect of crude oil prices and macroeconomic uncertainties. We expect this market to remain challenging for the rest of calendar year 2016 and into 2017 with no significant downward or upward movements.

Geographically Asia, led by China, and Europe was stronger than forecast. Our Asia business, excluding Japan, grew double digit, driven by greater than 25% growth in China.

While the overall European market remains challenged, we delivered solid mid-single digit growth. European pharma and food markets were strong. And academia and government funding was stable with Q3.

Japan and the Americas were flat, with growth constrained by continued chemical and energy market weakness. And specific to the US, slow US government funding.

Moving onto the business groups, Life Sciences and Applied Markets Group delivered core revenue growth of 5%. Better than expected revenues from our analytical lab instruments business was driven by an attractive combination of introducing new products into growing markets.

This applied in particular to our new lineup of chromatography and mass spectrometry products targeted at pharma and applied food, environmental and forensic markets. LSAG's operating margin for the quarter was 22.8%, up 280 basis points from a year ago.

We are building for the future. In August we introduced a transformational Intuvo 9000 GC system. Building on our recognized GC leadership, the Intuvo system revolutionized the way users performed gas chromatography.

Industry experts recognize the unique innovation being delivered by Agilent, with press coverage at 100% positive. Intuvo is featured this month on the cover of LCGC Magazine, a major trade publication.

Customer response is also very positive to this introduction, confirming our undisputed market leadership in gas chromatography. We anticipate a measured uptake in revenue. Limited international shipments are expected in Q1 of FY17, with volumes expected to increase over subsequent quarters.

Another industry unique product, the Agilent 8900 Triple Quad ICPMS system, which we've just introduced in Q3 is also being well received in the market. This instrument is rapidly becoming the solution of choice in labs that demand the highest standards of performance.

Next, the Agilent CrossLab Group continues to deliver strong sustained growth, with core revenue up 8%. Growth is healthy in both services and consumables.

ACG's operating margin for the quarter was 22.7%, down 240 basis points from a year ago and in line with expectations. ACG results are driven by strong pharma, food, clinical and diagnostic markets, where our CrossLab customer value proposition is being well received.

Unlike our instrument business, ACG also grew in the chemical and energy markets. Laboratories supporting strong production levels drove demand for consumables. There is also a continued demand for services, as customers focus on keeping their older instruments operational.

We are investing for the future in ACG. We just introduced a new range of innovative and differentiated supplies. These new offerings enable the Agilent Intuvo 9000 GC to be the most efficient and cost effective premium GC to own and operate. We continued to successfully integrate the recently acquired iLab business, which brings differentiated capabilities to core lab managers.

Last, but certainly not least in terms of impact, the momentum in the Diagnostics and Genomics Group continued with delivery of 8% core growth. Our laser focus on improving the previous acquired Dako business is paying off.

The pathology business continues its steady climb back to market growth rates, with strength in reagents and companion diagnostics. Our nucleic acid solutions business, for which we recently announced a significant production capacity, grew double digits.

This growth reflects increasing demand for oligo and nucleotides for RNA-based drugs. DGG's operating margin for the quarter was 19.6%, up 40 basis points from a year ago.

In October there was some exciting news from Merck for lung cancer patients and for Agilent. Merck's Keytruda is now approved by the FDA for first-line treatment for metastatic non-small cell lung cancer for patients with high rates of PD-L1 expression.

In conjunction, Agilent's pharmaDx companion diagnostics PD-L1 test is now approved for expanded use. This is the first time an Agilent's PD-L1 companion diagnostic is approved for first-line testing.

The theme of investing for our future is also evident in DGG. We launched a comprehensive offering of pooled CRISPR libraries for functional genomics. This will help accelerate research into complex diseases and drug discovery.

We signed an agreement with Burning Rock Biotech to develop cancer diagnostics in China based on Agilent SureSelect solutions. And we broke ground and initiated construction on the previously announced $120 million investment in a new factory in Colorado to expand nucleic acid production capacity.

Turning now to operating margin, we remain focused on operating margin improvement. Since the new Agilent leadership team was appointed, we have delivered seven consecutive quarters of improved operating margin and strong growth.

Despite continued challenges in the chemical and energy business, we have improved adjusted operating margin by 280 basis points in the first two years of the Company's transformation. We have completely absorbed and offset the $40 million of dissynergy costs due to the spinoff of Keysight.

On the operations front our Agile Agilent Program continues to simplify the Company and lower operating cost. This program is designed to keep us nimble, improve our interaction with customers, and lower our costs.

It is having an impact, and will continue to deliver saving in 2017 and beyond. In the coming year we will realize cost savings from the completion of the integration of Dako in early 2017, a simplified enterprise IT systems environment, and other cost savings initiatives.

Turning to our FY17 market and Company outlook, as a reminder, our shareholder value creation model for superior earnings growth is to outgrow the market and expand operating margins with a balanced deployment of our capital.

Didier will go through the specifics of our Q1 2017 and full-year guidance. I want to share our of thinking about end markets and our initial guidance philosophy, given an environment of increased uncertainty.

This is a change to our last call and the May 2016 Analyst and Investor Day. In our end markets we expect continued strength in pharma, accompanied by continued solid growth in the food, environmental and clinical research and diagnostics markets.

Geographically, China and India are expected to grow at significantly higher rates than other countries. There remains considerable uncertainty about European markets. We are forecasting moderate growth in the United States, with US government policies and spending, and chemical energy markets being the wild cards.

Chemical energy, while entering a period of easier compares and improved oil prices, has not yet returned to growth. We expect a continued subdued academic and government research market in the coming year until uncertainties resulting from Brexit and the US elections play out. We are also keeping a watchful eye on how potential new US government-driven trade and currency valuation discussions could impact our business.

We finished 2016 very strongly. And we are well positioned for future growth with a pipeline of new offerings. In our initial revenue guidance for 2017, however, we want to be on the cautious side. We want to see some more clarity on US and European government actions, and have better indicators of when we will return to growth in our industrial end markets.

Predicting end market growth in today's uncertain political and economic environment is challenging. However, I can predict quite confidently that we will continue our track record of outgrowing the market, whatever market environment we encounter. We continue to expand our customer channel reach and fortify our portfolio, which strikes us well for the coming year an beyond.

The transformation of Agilent we discussed at the May Analyst and Investor Day is in full force. The new leadership team put in place in early 2015 continues to deliver strong operating results each and every quarter.

We are building momentum for future growth. We have improved our adjusted operating margins by 280 basis points(corrected by company after the call) over the past two years. And our march to improve operating margins will continue in 2017.

However, in our initial operating margin and earnings per share guidance for 2017, we want to be on the cautious side. Since our May Analyst and Investor Day meeting change in the exchange rate, pension expenses and the recent iLab acquisition are having a short-term dilutive impact on our operating margins of 0.5%.

The Agilent team, however, is laser focused on improving another 130 basis points of operating margin. We have internal action plan, aligned with achieving a 22% operating margin goal in FY17, excluding M&A impact.

This is the primary goal for our executive team's compensation. We continue to hold ourselves to a higher level of performance expectations than reflected in our initial full-year earnings guidance.

As you assess our future possibilities, I will leave you with a few thoughts. We are expanding our product portfolio and extending into adjacent markets. We are improving the customer experience by streamlining processes and modernizing systems, making the Company more efficient and customer friendly.

Our Agile Agilent Program has and will continue to deliver incremental improvements in operating margin. The One Agilent team continues to work well together, and is determined to win in the market. We believe we are well positioned to sustain our strong operational performance and achieve our long-term goals. The entire Agilent team is energized and committed to delivering future growth.

Thank you for being on the call today. I will now turn it over to Didier who will provide initial insights on our financial results and initial guidance for our fiscal Q1 and full year 2017. Didier?

Thank you Mike, and hello everyone.

As Mike stated, we are very pleased with our Q4 and full-year performance, both well over the high end of our guidance.

We delivered above market core revenue growth of 6.3% and 5.9% respectively. And our operating margin, adjusted for income from Keysight, was up 60 basis points, 110 basis points respectively. Our full-year EPS at $1.98 is 14% higher than the previous year.

Please note that we have reduced our pro forma tax rate by 1 percentage point, which had a $0.02 impact on our EPS. Our operating cash flow for the full year at $793 million reflects our strong overall performance.

And turning to capital returns. For the year we returned $584 million to shareholders in the form of dividends and buybacks, or 89% of our free cash flow.

I'll now turn to the guidance for FY17. As Mike stated, our initial guidance, like last year, assumes that what we believe to be appropriate caution. Our FY17 revenue guidance of $4.35 billion to $4.37 billion corresponds to a core revenue growth of 4% to 4.5%. It is based on October 31 exchange rates. And currency had a 0.6 percentage point impact, a negative impact on revenues.

We project FY17 adjusted operating margin of 21% to 21.5%. And FY17 EPS of $2.10 to $2.16, growing 8% at midpoint.

As you update your models for FY17, please consider the following 10 points. First, annual salary increases will be effective December 1, 2016. Second, stock-based compensation will be about $59 million. And as we front-end the recognition of stock-based compensation, the Q1 expense will be about $23 million.

Third, the reduction in bond yields is negatively impacting our annual pension expenses by about $12 million. Fourth, depreciation is projected to be $104 million for the fiscal year.

Fifth, the non-GAAP effective tax rate is projected to remain at 19%. Sixth, we plan to return approximately $600 million in capital to shareholders, including $170 million in dividends and $430 million in buybacks, subject to customary conditions.

Seventh, we plan to grow $260 million in the second half to fund a portion of our capital returns. Eighth, net interest expense is forecasted at $71 million and other income at $11 million.

Ninth, for purpose of our EPS guidance we have assumed a diluted share count of 324 million shares, 5 million shares less than the average diluted share count in FY16. And finally tenth, we expect operating cash flow of $825 million and capital expenditures of $200 million, about $60 million over FY16, mostly due to the investment in the second nucleic acid facility.

Finally, moving to the guidance for the first quarter. First, please note that Lunar New Year falls in Q1 this year versus Q2 last year, meaning about $15 million of revenue shifting from Q1 to Q2.

We expect Q1 revenues of $1.04 billion to $1.06 billion. And EPS of $0.48 to $0.50. At midpoint revenue will grow 2.2% on a core basis and EPS will grow 7%. And as customary, Q1 EPS is negatively impacted by the December salary increase, front-loading of stock-based compensation, and increase in payroll taxes due to the disbursement of the variable and incentive pay of the previous year.

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

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

Certainly.

(Operator Instructions)

Our first question comes from the line of Steve Beuchaw from Morgan Stanley.

Hi. Good afternoon, and thanks for all the color and for taking the questions.

Sure.

First question from me is, I wonder if you could just juxtapose your results against from what we've heard from others in the category over the last several weeks? Sounds like a particularly strong category by a number of -- quarter by a number of metrics.

You actually accelerated where we saw a number of others decelerate in terms of organic growth in the quarter. Can you give us from a high level what you think are the keys there in terms of positioning, why it is the quarter was so good for you guys relative to the market?

Thanks, Steve. The headline for me was, as we looked throughout the quarter, we were winning more business than we planned. So we're winning a lot of business in our core markets.

I think some of the end market strength that we pointed to was actually fairly similar to what I've seen other people comment on relative to the strength of China, strength of pharma, continued subdued but kind of a stable, actually even government, and environment. And for us I think we were just delighted by our performance, in particular in our analytical instrument business where we seem to be winning more business than we planned. And we think that bodes well for the strength of our portfolio and some of the things we've been doing over the last year in our channels as well.

And then so the follow-up, I guess, just to dig a little deeper would be, did you notice anything in terms of instrument trends relative to consumables trends accelerating or decelerating? And what is that telling you about end of year, I should say end of calendar year budget flush? Thanks so much.

We were talking a bit about this yesterday with the team. If you look at our performance through the quarter, we got off to a strong start in August. And it continued throughout the quarter.

And sometimes it's hard to tell [from] the first month where things are going to land for the quarter. But I'd say by the end of September we knew we were winning more business than we planned. And it's really shaping up to be a strong quarter for us, and really position us well for us going into 2017.

I really appreciate all the color.

Thanks, Steve.

Thank you. And our next question comes from the line of Tycho Peterson from JPMorgan.

Thanks. Mike, just hoping for a little bit more color on some of the expectations in guidance, and particularly around pharma. Are you still assuming that's kind of double-digit growth next year, or are you factoring in a moderation?

And on environmental, you managed to grow that business in contrast to what we saw from one of your peers last week. Maybe talk a little about contributions from the GC replacement cycle for next year as well.

Yes, sure. Tycho, you broke up a bit on the call. So if I don't get to the specific questions, please come back to me. But I think relative to the expectations for end market kind of thinking for growth rate, we had pharma below the double digit growth that had been in place in 2016.

As we look at our end markets, we would expect a moderation of growth, not because the spends are going to go away. But you're really going to start to get into tough compares. And Didier, if I remember correctly, we were in the mid- to high- single digit growth for pharma.

Yes.

And then I think the story -- I think, Tycho, the question was around environmental.

Yes, and the GC replacement cycle.

So in environmental the story really there is China. And we think that's got many quarters in front of us of growth in China. As you know, I'm fairly bullish on the prospects of that market. And I think we got kind of a perfect storm here going on where we have strong products going into the growing markets.

Relative to the GC replacement cycle, this is really about what's going to happen in the chemical and energy market. And I'll make a few comments here. Then Patrick, you may want to provide your perspective as well. So you may have noticed in my call script I went kind of out of my way to talk about a measured ramp-up of our new Intuvo GC because we think we've got a winner product on our hands.

We know there's a lot of interest from customers. But we also recognize the reality of constraints they may have in their capital budgets. I know they're working with their own management teams internally of these companies about what they may get in terms of funding in 2017. What are your thoughts, Patrick, on that, as well?

Thanks, Mike. Looking at the GC market, we definitely are positioned very well to capture any growth opportunity there. We have launched Intuvo, which is a strong message to our customers that we are standing behind them when it comes to drive for lower cost of measurement, when it comes to lower cost of ownership, when it comes to increased productivity. And it positions us clearly as the market leader in gas chromatography.

We're in a lot of discussion with them, not only on the Intuvo, but I think what the Intuvo launch did for us, we also -- it also spurred a lot of discussion again about other -- of our other product portfolio, the 7890, and other products which are market leading products. And again, the discussion with the customers in the suppressed market is all about, how can we help them increasing productivity, driving their cost of analysis down. And this is where we are exceptionally well positioned with this portfolio.

Maybe just to put an exclamation point on this is that we know that the installed base is at historic levels of aging. We know the equipment's being used.

And it's just a matter of time for that replacement cycle is going to turn on. As you saw in my call comments, we're not ready to call that yet.

Okay. Just one clarification on the operating margin guidance. Half of the cut -- you're down 1% from what you talked about at the Analyst Day.

Half that is from iLab pension and FX. Is the rest just conservatism, given kind of the macro?

I think actually where we had was the high end of the guidance was around 21.5%, right Didier?

Yes, with the high end is at 21.5% and we are losing about 50 basis points related to the three items that were mentioned, currency, acquisition, and pension expenses. And the other thing to note is that as Mike has clearly stated, we are still being measured on achieving 22% in terms of our variable compensation.

The way Didier and I talked about this one was, listen, we think we've got a path to 22%. But there's a lot higher risk than there was back at the last call and at the May Analyst Day.

So we thought it was prudent for us to guide this way. We're all out inside, all our of comp is tied to the 22% number.

Understood. Thanks.

The three elements were clear headwinds.

Thank you.

You're quite welcome.

Thank you. And our next question comes from the line of Ross Muken from Evercore ISI.

Hey, guys. This is Luke in for Ross. Hoping you could give a little more color on your margin assumptions for next year? What you guys are thinking about pacing the FX headwinds, if any? What's going to be operational, what's pricing, et cetera?

I think the question, Didier, was relative to the composition of our operating margin improvements for next year. And perhaps we can start with the mix between volume and OpEx and gross margins.

Yes, I mean, I'm not going to give you the full bridge. When we provided the guidance of 21% to 21.5%, we took into account obviously all the impacts that I've mentioned. So there is -- it's based on 4.3% core revenue growth.

There is clearly an operating leverage impact. And a lot of actions that are taking place to offset inflation and other headwinds that probably I have mentioned. The guidance assumes some level of increased improvement in gross margins, as well as a reduction in terms of the OpEx as a percentage of revenue.

So you have pretty much on all fronts some improvements, not as much as we had initially anticipated because of the three headwinds that I mentioned. Some of it's related to operating leverage. And some of it's related to the continuation of our Agile Agilent programs.

And maybe if this were -- reminding the audience, Didier, when we first started on this march almost two years ago to go to the 22%, we laid out a path, which was really around 60% being volume, the other 40% was going to be on OpEx improvements and gross margin. I think we're thinking about the same kind of mix for 2017.

Great. And I guess just one more. You guys did really well on the cash flow in 2016, I think $647 million. You're guiding for $625 million.

Is there any timing impact on that 2017 guide? And then I guess on the tax of 2017, what are you baking into that benefit down there?

I assume when you refer to timing impact, you're referring to special -- I mean, between 2016 and 2017, some cash outlays [only that could -- ]?

Yes, correct.

There's a little bit. Let me just highlight two potentially. In FY16 we disbursed $66 million for overall Agilent variable pay and pay for results. Next year we -- but we've changed our program so that we now do a lot of the cash outlays on an annual basis instead of semi-annual.

We have the full brunt in 2017 of improvements in 2016. And the fact that we're going to pay in 2017 something that is more than pertains to 2016. So it's going to be $91 million, going from $66 million to $91 million, an increased capital cash outlay.

And then second, we did not fund our US pension plan in 2016. So our overall contributions to our worldwide pension plan was $24 million. We intend to fund our US pension plan more in 2017. And the contributions to the pension plan will move to $45 million. So an increase from $24 million to $45 million.

So those are the two things that come to mind in terms of explaining some of the variance between 2016 and 2017. Even with those two headwinds, we are still showing in our initial guidance a nice increase of $30 million on a year-over-year basis. And your second question?

Relates to tax rates.

On the tax rates, I did mention at the May Analyst Day that we were going to work really hard on reducing our tax rate by 2 percentage points over the course of the next two to three years. We are very happy to be able to deliver already 1 percentage point in this FY16.

We still are aiming to reduce our effective tax rate by other 1 percentage points over the course of the next 24 months, as committed to or as indicated, I would say, in fiscal year -- at the AID. But it's prudent to assume that the reduction will come in FY18 and not in FY17. So in your models we advise you to put a 1 percentage point reduction in tax rate from 19% to 18%, in FY18, not in FY17.

Does that include the FASB2-1609 benefit?

It includes everything.

Okay. All right. Thank you.

You're quite welcome.

Thank you. And our next question comes from the line of Doug Schenkel from Cowen & Company.

Hi, this is Ryan Blicker on for Doug. Thanks for taking my questions. Would you be willing to provide what your LC/MS growth was in the quarter, and how that was impacted by the comparison relative to recent quarters? And maybe what your annual growth was there?

What I can tell you is that, back to my earlier statement, is we're winning more business than planned. We're quite pleased with how we've been doing with the LC/MS portfolio. And Patrick, you may want to remind the audience some of the new stuff that we've come out with.

I guess I'm not comfortable with giving the specifics of the growth rate. But just giving you a sense of trend of the business. And maybe a few proof points why we believe it's going as well as it is.

Sure. Again, we are confident that we are outgrowing the market on many fronts. We have a very strong LC/MS portfolio.

We launched a lot of exciting products at ASMS this year. I think the reception in the market just underlines our strength.

The combination of LC and [LC/MS is] important, and we think both are winning platforms. We see strong adoption across all the end markets.

If there was one market where we have seen some headwind, then it was probably the pain management market segment. But, as I said, that is also in line with what you've probably have heard from some of our competitors. Overall, we have been very pleased with the result in Q4.

Okay. That's helpful. And then it seems like there could be a repatriation holiday of some sort in 2017. I believe over 90% of your cash is currently trapped internationally. Can you provide any initial thoughts on how you would prioritize repatriated cash, specifically on M&A opportunities and returning capital to shareholders? Thank you.

Sure, Ryan. Didier, how about I make a few initial comments and then if you want to add anything to it. First of all, I think we also need to put a series of caveats on my response because we really don't know what this might look like, what strings might be attached to, how you can use it, whether you can use cash in a certain way.

Obviously we would welcome this type of development, including a move to a more permanent reduction in US corporate tax rates. That being said, I think if you go beyond the theory, with those caveats, I think what you'd expect us to do is handle the return to cash very much along the lines of how we're managing our current use of capital.

So we would want to use it for US-based M&A. And we'd like to use that in situations where we've been using debt, such as our share repurchases. So we would be able to finance our share repurchases. And then we might look at our debt structure.

I think what we'd want to do is, first of all, obviously understand what are the restrictions that could be tied to it. Also remind the group that some of the cash does need to remain permanently invested overseas.

If that particular situation would develop, we would likely bring it back and use the cash very much along the lines of how we've been using cash, with the exception is, I won't need to borrow money like I've done in the past for US-based M&A or stock repurchases. I guess you must be okay with that, Didier. You haven't said anything else.

We're just waiting with baited breath for the fine lines on any chance. But, yes.

Thank you. And our next question comes from the line of Jonathan Groberg from UBS.

Thanks. Mike, so I was just going back and looking. You did 6% growth organically on core last year, 6% this year in 2016.

Just at a high level, you had some pretty tough businesses in some of the industrial businesses this year and still put up 6%. I guess I'm just wondering as you look out to 2017, are there some initial thoughts you have around the election from an end market standpoint outside of tax that make you incrementally concerned? Is there -- maybe just high level, what makes you think you're going to get that kind of 150 Bps slowdown year over year?

Great question, Jonathan. Thanks for that. Obviously we spend a lot of time talking about this as a team. And I mentioned to Alicia before the call, I think we may be the first Company in our space that had to do guidance after the US election. So what I'm going to tell you is kind of factors we're thinking about. And then also give you maybe a little bit more thinking about why we guided the growth rate we did as a Company.

But we don't yet have a position on these issues. What we do know is there's a multitude of factors that we need to pay attention to. Regulated markets, what's going to happen to our customers in the food markets, the environmental markets, the FDA regulatory markets.

We know there's going to be a customer impact. What's going to happen with US government funding? A lot of our business is driven by US government funding.

What's going to happen to trade agreements? There's been a lot of noise about Chinese currency. We just talked about the tax. And will the M&A environment change in terms of -- so all I can say right now, Jonathan, is perhaps like everybody else on this call, we kind of had a sense of the issues but we don't know which way these things are going to go yet. So we're not going to call them.

That's one of the reasons why we took what we believe to be a prudent, cautious initial guide to FY17. If I look at the end markets, pharma is going to continue to be strong. But we don't believe that it can continue to grow at double digits throughout all of that by FY17. So we've tapered down our expectations a bit about pharma.

We also think that China's been just fantastic for us. I think our number for the year was 21% growth for the year. I'm dialing that back a bit to double digit.

So what we're doing is really just trying to moderate our view of growth for next year based on what we've seen to be some pretty difficult compares in some markets that really have been driving the business. As I mentioned to you, the wild card is the turn on energy.

One of the things that you pointed out, Jonathan, and what I'm really delighted is we've had close to 6% growth two years in a row with our number two market declining for eight quarters. When that market turns, that obviously will help us [in the] grow.

But I've learned over the first two years in this job, it's really hard to call turns of major markets. So I'm not going to. And we'll just kind of keep an eye on it, and we'll update you as we go through the year. But that's our thinking about how we're viewing the US elections and the thought behind our end market guidance for next year.

Thanks. If I could, just one more on the diagnostic and clinical market.

Jacob's been dying to answer a question.

So obviously another 8% growth there. Obviously, you're probably going to say too early to think about how hospitals may react to the potential repeal of the ACA.

But how about the PDL-1 testing business? How much of your growth was driven by that market, and can you size that market for us yet?

Well, I can start by saying that we have been very pleased with the performance of the PDL-1 over the last 12 or, I think, it's 13 months now. And it has grown, if not to our expectation, then above even.

And we expect that to continue to grow now based on Keytruda going first-line. And obviously now with our companion diagnostic, we will see a bigger demand for in US, in Europe, and in other regions. The market itself is very difficult to size, as you know. That's both in the companion with one drug. And then has been the complementary with another drug. And those have very different franchises at this point in time.

I still believe that the overall PDL-1 market might end up in the same size as the HER2 market. But the difference is that HER2 is only one -- basically one drug, one class of drug together with one diagnostics where the PDL-1 would be up to five different drugs, maybe more, and five different diagnostics, maybe even for a lot of indications also.

So this is as close as I can get to right now. The market we place in is, the two companion diagnostics that we have today, continues to grow strongly.

I won't say that, that's the overall [arching] driver for the 8%. Basically all our businesses today have a very nice growth performance, but it's definitely contributing.

Thanks.

Thanks, Jonathan.

Thank you. And our next question comes from the line of Derik de Bruin from Bank of America.

Hi. Good afternoon.

Hey, Derik.

Hey. The pace in the quarter was very good. Can you talk a little about backlog? And, I guess, did you pull -- are you worried that you pulled anything from the first quarter in? I mean, any unusual spending patterns that you thought?

Thanks for the question, Derik. So as I mentioned earlier, we saw strength throughout the quarter. And we were quite delighted with the results. And we're not specifically commenting about quarters or backlogs, but I did say in my earlier comments that we're well positioned for 2017.

I would ask you to think about the Q1, particularly the impact of Chinese Lunar New Year. I told Didier, I said I don't want to talk about it in the Q1 call, so let's make sure that we include it in our guide. So that is the one thing that I would ask you to think about in terms of the next three months of the Company's performance. Because we think we'll probably push about a week's worth of revenue or so from Q1 to Q2 because customers just won't be there to take delivery. And as you saw, the growth rates have been really exceptional for us in China.

So I'm going to -- I appreciate the New Year's comment and I'm actually going to follow that up with another question. Have you had any conversations with your customers that -- obviously you're not the only ones trying to figure out what the new world order of is in terms of how spending is going to be? Are you worried at all about potential in terms of lower CapEx spending, lower spending at the beginning of the year as people try to get their arms around what exactly the new administration has in store?

No, actually we don't have that concern. What we've been more thinking about is where is this thing going long term?

But in the next quarter, we don't have any real concerns about that. And that's why we are doing a full-year guidance here in November. And it was really hard to see what's going to happen longer term throughout the year. But in the next quarter or so, we wouldn't expect that to have any significant impact.

Great. Thanks.

Thank you. And our next question comes from the line of Paul Knight from Janney.

Hi, guys. This is actually Bill on behalf of Paul. How are you doing?

Hey, Bill. How are you?

Doing well. Maybe touching on China again. Could you maybe talk about what underlying trends have been driving the outsized growth for the Company?

Is it biopharma? Is it food? Is it environmental? How does that impact as you look to next year? Thanks.

Thanks for the question. I have to say, it really was across the board, with one exception which is the chemical and energy markets. All the other markets were up quite substantially for us.

And I think this is consistent with what we had talked about in prior calls, which is really there's going to be a level of investment in China relative to quality of life issues, environmental and food, lined up directly with their five-year plan that they're in the midst of a major improvement in their overall pharma industry. And that there's a lot of money going into research.

Then I think the reason Agilent has been able to do so well here is we've got this combination of we've been working the organizational structure, our channel model in the country, we've had a lot of stability over the last 18 months. So we've got a really strong team there.

And that combination of the team, our historical strength in China, and the new products we have, it's all coming together in terms of growth. I guess maybe I'll just add one thing. Mark, perhaps you can comment here.

We often talk about the strength of end markets and the new products going into these end markets. But I think there's something going on relative to your business there and the move to services I think it's worth commenting on as well.

Thanks, Mike. And thanks, Bill. To add a little color to that, is we've seen a fundamental shift in buying behaviors in China, largely shifting from the core areas and around Shanghai, Beijing, to some of the more Tier 2, Tier 3 cities where services now is viewed as a commonplace purchasing item in China. And it's certainly driving the growth.

The breadth of services, I think in China, as well as the consumables business now, is the rest of the story where they have reached the size and scale that they have the same interest that we'd find in the Western markets around enterprise services and consumables all coming together. So starting as you mentioned, Mike, with our extraordinarily strong position to start with, the install base of China has just allowed us to build the business and truly outgrow our expectations in the second half around this, too.

I mentioned -- I asked Mark to comment on that because as you may recall, we really have changed the portfolio composition of the Company to be much more in the aftermarket. So [CapEx] instruments are actually less than 50% now of total Company's revenue.

And historically, China has been driven by new instrument purchases. We're seeing increasing growth also coming from services and consumables.

Great. Then just a follow-up for Didier on the guidance. CapEx up to about $200 million this year. Could you maybe just talk about where the incremental dollars are going?

And maybe what you think the maintenance CapEx is for Agilent as a whole? Thanks, guys. Have a good one.

The main reason for the increase, which is about $60 million, from $139 million this year to $200 million next year is really the significant increase that we are planning in terms of our nuclear acid facilities, RNA-based therapeutics in Colorado. So we had one facility.

We're still expanding the capacity of that facility. But we are building. And we just started a few weeks ago 20 miles away a second facility that will kind of double the capacity when it will be put in production end of 2018, 2019. That is the main reason for the increase.

Starting in 2018 we should start -- we will see a reduction in the CapEx. This is not the run rate. Our CapEx run rate is still between $100 million and $120 million per year. This is way above our run rate.

Thanks.

Sure.

Thank you. And our next question comes from the line of Jack Meehan from Barclays.

Hi. Thanks. Good afternoon. Wanted to follow up on the diagnostics business. Really thought it was a nice quarter on a tough comp. You talked about the PDL-1, but just wanted to focus on the Omnis, and just whether you think you're picking up steam into 2017? And anything worth watching on the reimbursement side with that.

Yes, Jack. Thanks for the question. I think I'll pass it over to Jacob, maybe get a little bit more color on the quarter results.

Yes. We really continue to see overall in our Radiance pick-up, driven definitely by Omnis that we see the growth is coming back. It's nice momentum we're seeing.

It has continues to -- basically it has continued to increase over -- during 2016. So with that momentum, we expect that we will continue to see a good performance into 2017 also.

From a reimbursement perspective, obviously there are already some expectation how that will look like into 2017 and 2018 with the [permits] on. Now we'll have to see what happens under the new Administration here whether that will change anything. So far we actually don't expect any significant changes in 2017.

Great. That's helpful. And then just wanted to follow up on the margin again. From our seat, what should we be watching and what would push you to the 22% above level for this year? What are some of the actions you think are going to be critical for doing that?

Didier, feel free to augment my response here. But I think obviously it's going to be volume, which is about 60% of the margin improvement comes from volume. And the things that we can control, we're on top of.

So it's really -- that's the one thing I can't control, is what's going to happen in the market. So obviously there's that 60% tied to margin.

And then we've got some pretty big initiatives in the gross margin area with our water fulfillment team. I think you may have heard me speak previously about some of our work in value engineering, material cost, reductions, and logistics. Also keep an eye on our gross margins as we work through the year.

Some of those things take a while to actually they start coming through your P&L. Once they're there, they're there for an extended period of time. And Didier, anything else you can add to that?

No just that we do have stretch goals, as we mentioned. We are paid internally on achieving 22%. And that means all of us have stretch goals to make -- to achieve that, to contribute to 22%. And the OFS and Henrick, the order fulfillment and supply chain organization, which has delivered greatly in 2016 is looking at opportunities to deliver even more in 2017, which would help us bridge the gap.

Thanks, Didier. One additional thought here is I think it's important to remind everyone, is that some of the things that are going to help in 2017 have already been finished in 2016. So things such as our simplification of our financial system's infrastructure, so it's done. And now the saving will show up in 2017.

Great. That's helpful. Thank you.

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

Good afternoon, guys. Thank you. Thanks so much. First question, just quickly on the quarter. Curious if you can comment on pacing.

You guys have the off-cycle calendar there with October. I'm sure everyone's curious whether it was on the capital spending side or any particular end market you saw a meaningful acceleration or deceleration in the month of October, to the extent that portends the rest of the calendar year?

No. I would just mention that what we saw was really strong pacing throughout the quarter. So it wasn't -- we didn't see something happen all of a sudden in the last 4 or 5 weeks. We had strength all through three quarters of our fiscal year close.

Got it. Thank you. Maybe a longer-term question, Mike, regarding management incentives. You guys have spent a lot of time over the last couple years talking about the emphasis on hitting your margin goals.

You guys have done that pretty well. As you move past that 22% number, wondering how you think about evolving incentive structure for the management team? Should we assume that the types of incentives you have in place stay in place, maybe with slightly different targets? Or could the overall composition evolve a little bit here?

Isaac, great question. I would point back to what we discussed back at the May Analyst Day where we really said, what this is really all about is generating superior earnings growth. If you think about what we're trying to do here, is we're trying to outgrow the market, expand the operation margin to keep driving up our adjusted earnings per share growth.

So what we like to be able to do is, really that should be the focus of the team as we move forward. Operating margin expansion and capital deployment and the growth in market are all ways to get there.

So we'd like to really be, that have become the cornerstone of our long-term focus. And we want Agilent to be viewed as a Company who grows their earnings faster than revenue.

But as I mentioned at the Analyst Day is, I really want to also make sure that we don't get so focused on continuing to drive up the operating margin year in and year out that you pass on things that are [immediately], say, accretive. Maybe they're dilutive on your margins, but with good M&A additions to the business. I think the way we're going to talk about the Company post 2017 is very consistent with what we had talked about back in the spring in New York City.

Got it. Thanks so much.

You're quite welcome.

Thank you. And our next question comes from the line of Brandon Couillard from Jefferies.

Most of my questions have been addressed. Mike, just curious what you're embedding for the government and academic market globally for next year? Any color you can give us regionally would be helpful.

Sure, Brandon. As I look through my notes here, I think we're expecting low single digit growth. I think it's important to kind of parse it out by academia and government.

So we think, if I go by the major regions, China is going to be strong. And they've actually helped mitigate some of what's been happening in the US and Europe.

We're not expecting much in Europe. It's been down. It was down again, but not -- it was basically sort of almost feels like the chemical and energy market, which is kind of chugging along at a reduced rate.

We're not expecting the governments there to do anything in terms of more stimulus. In fact, one of the things we're watching is what are they going to do as a result of Brexit, among other things.

We expect a strong China, academia, and government. We expect a continuation of this current environment in Europe.

In the United States, the academia side is not bad. What we've seen more it's been on the US government side.

The US government, our US government business is down in 2016 relative to 2015. And that's why in my call I mentioned, we need to see where this new Administration goes with its budget plans and investment priorities.

So right now we're kind of staying on the sideline, just saying it's going to continue do be just like it is but -- in the United States. But we could see something different in a few months. We just don't know.

Super. Thanks.

You're quite welcome.

Thank you. And our next question comes from the line of Dan Arias from Citigroup.

Hi, guys. Thanks for getting me in here. Mike, just following up on the outlook.

How are you thinking about the pacing of growth in chemical and energy in 2017? Is the assumption that you kind of see some sequential improvement through the year, or are you basically flat-lining the business across the quarters, given that we haven't seen much in the way of positive signals?

I think you anticipated my answer. So we basically have a flat line for the year and it hasn't -- it's been shrinking for the last 7 or 8 quarters, 2% or 3%. I think we ended up down about 3% for the full year.

And we're basically saying it's going to be flattish for 2017. If there's any good news to that story is, the fundamental industries are still out there in terms of gasoline is being produced. We've seen record levels of production in United States, for example.

The plants are running. There's a lot of discussion. There's a lot of reports externally about a turn.

Oil prices have been inching up. But our history here is that it's really hard to know exactly when it's going to turn.

What I can say is that if you have a profitability productivity message associated with something you can bring to the laboratory, then they might listen to you. And we're hopeful that some of our new product introductions will hit the mark there.

But in terms of our overall market assumption and growth assumption for the Company, we're assuming flat for 2017. No big movements one way or another.

Got it. Okay. Great. And then maybe just to go back to the M&A and the margin comments. As we sort of think about the moving parts on the op margin guidance and just what you might look to do this year, how at risk is the current op margin outlook from additional that M&A? Obviously it's tough to discuss these things in the abstract. But are you open to further dilution if the right asset comes along? Or do you kind of think you hold the line at the current forecast? Thanks.

I think what we've said, and I'm really trying to be -- have actions that are consistent with our prior communication. We said we would look at acquisitions that could be short-term dilutive in nature.

And we did one latter part of 2016 and we just love having iLab part of the portfolio. It's going to be -- it's a great addition to the business. But right now it's not at the corporate average. We'll move it up.

So if we saw other opportunities like that, we would pursue them. But I think if you want to look at the type of deals and the size and other things, just look at what we've done so far to give you kind of a sense of the things that we're looking at going forward. We like accretive deals. And we like ones that can move up -- move the barges up.

Right. Very helpful. Thanks.

You're quite welcome.

Thank you. And our next question comes from the line of Puneet Souda from Leerink Partners.

Thank you for taking my question. Appreciate you squeezing me in last minute.

Just quick follow-up, if I could, on the pharma end. Just wanted to understand, there's clearly a solid contribution here.

If you could maybe help us parse out, is that more coming from sort of small molecules or macro molecules, or is this -- are we thinking about them correctly? Maybe we should be thinking about in terms of the service contract share that you're gaining and via the CrossLab Group? Help us if you could parse that out a little bit.

Sure. So there's a couple things going on, which is in terms of the overall fundamental end market growth rates we think biopharma and the small molecule side of pharma are both growing quite strongly.

Small molecule side is really being driven by a conversion to the new technologies, liquid chromatography in particular. Also an increasing interest in enterprise service, what we have to offer from ACG.

So I think what's been going on here for Agilent, we've had a combination of really strong end market growth. There's a new market that has and will continue to develop in the services side. We're doing well there, along with our new instruments in the pharma.

When I look at 2017, we think that the biopharma side of that market's going to continue to go quite strongly. It's been an area of prioritization for us in terms of new solutions.

But we do think that over time, that the small molecule stuff will start to move back towards more of a long-term growth rate. Patrick, I think -- what do we kind of think about a long-term growth rates in the small molecule side?

On the small molecule side I think more in the low to mid single digits range, whereas in biopharma we're more optimistic. It continues to be double digits. That's our projection right now.

Does that help?

Yes, thank you for that. One more. In terms of the chemical energy markets, we get the you view into 2017. But as you have conversations with the labs and lab directors, just help us understand how they're thinking about capital equipment in 2017?

Knowing these times and knowing that the progression that's been? Or are they thinking more in 2018 terms on the capital equipment?

I have to say, I don't think they really know yet, as well. What they're doing right now is they're right in the midst of their capital budgeting process.

So what I can tell you is that I've had a couple conversations with customers over the last two or three weeks on this exact topic. And what they describe for me is -- hey, our end -- these are -- one customer was somebody who provides services into and equipment into the energy market.

Listen, we're starting to get interest in quotes. But we're not sure whether it's going to hit in 2017 or 2018. When we had our VIP launch for the Intuvo 9000 GC a lot of our customers were in the chemical and energy space. And they said -- listen, we love this productivity message you have here. I think there's a real economic ROI. I'm now right in the midst of my budgeting process inside the company. Maybe I'll be able to he get this thing through this year or maybe the following year, because there still seems to be this sentiment, particularly with the larger companies, they want to hold onto the equipment as long as they can before they have to replace it.

So -- and again, that's why I pointed to the fact it's not all negative because of the fact we do have a strong service and consumables offering into that space. But again, we just don't -- I don't think our customers know yet, as well, what's going to happen.

We do know it's going to happen. History will repeat itself. There will be a replenishment of aged equipment. But again, we're just not confident enough right now to say when that's going to occur.

Okay. Thank you, Mike. Thanks, Didier.

You're quite welcome. Thank you.

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Alicia Rodriguez for any closing comments.

Thank you, everybody. And on behalf of the management team, I wanted to thank you for joining us on the call.

If you have any questions, feel free to give us a call in IR. Appreciate it very much. Bye-bye.

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