Agilent Technologies, Inc. (A) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2017 Agilent Technologies Incorporated Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now look to introduce your host for today's conference, Miss. Alicia Rodriguez, Vice President of Investor Relations. You may begin.

Thank you, Crystal, and welcome, everyone, to Agilent's Third Quarter Conference Call for Fiscal Year 2017. 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 Science and Applied Markets Group; Jacob Thaysen, President of Agilent's Diagnostics and Genomics Groups, 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. Unless otherwise noted, all references to increases or decreases in financial metrics are year-over-year. References to revenue growth are on a core basis, core revenue growth excludes the impact of currency, the NMR business and acquisitions and divestitures within the past 12 months. Guidance is based on exchange rates as of the last business 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, and thank you for joining us today. Q3 marked on a strong quarter for the Agilent team. We exceeded our own expectation of both the top and bottom line. We continue to deliver above-market growth. Our revenues of $1.11 billion grew by 7.5% on a core basis. Adjusted EPS of $0.59 is up 20% over last year's third quarter. Our focus on operational excellence continues to pay off. We delivered an adjusted operating margin of 21.5%, up 90 basis points from a year ago. I can remember when I became Agilent's CEO, you asked me a very good question: could Agilent make the adjustments to improve our operating margin while outgrowing the market? Well, we have. This is the 10th consecutive quarter of improving core operating margins while outgrowing the market. So where is our strong Q3 growth coming from? From an end-market perspective, both the chemical -- global Chemical & Energy and Pharma markets grew by 10%. And geographically, China continues to be strong, while we experienced better-than-expected growth in Europe. Let's take a closer look at what's happening in our end markets. Our pharma revenue is up 10%. We are well positioned to capture growing customer demand with our broad and differentiated offering of instruments, services and consumables. Demand was also strong for our API offerings. Chemical & Energy is up 10%. This is the second consecutive quarter of double-digit growth. Similar to last quarter, growth was broad-based across regions and products. Our customers are beginning to upgrade their labs and are investing in equipment replacements. While some uncertainty remains on the pace of recovery, we are encourage by the reinvestment. After 4 consecutive quarters of decline, we had a nice surprise with the low single-digit core growth in Academia and Government. Strength in Europe and double-digit growth in cell analysis, spectroscopy and services drove our results. Food grew 2% against a difficult compare in Q3 last year. Food market fundamentals remain sound with strength this quarter in Europe. Environmental and Forensics grew a healthy 7%. Our strong growth was driven by Asia-Pacific and the Americas. Concerns about the health of our environment continue to drive the Asia market. Diagnostic and Clinical grew by 6%, led by pathology and companion diagnostics, and geographically, strength in Europe. Now turning to look at our different regions. Geographic performance was driven by double-digit growth in Europe, and continued China performance. The Americas grew by mid-single digits, while Japan was flat. And now let's turn to the highlights from our business groups. The Life Sciences and Applied Markets Group delivered core revenue growth of 7%. From an end-market perspective, strength in Chemical & Energy, Pharma and Environmental continued to drive the performance. Looking at our product portfolio, growth is broad-based across all our products, and we continue to strengthen our lineup. We recently introduced 7 new additions to our InfinityLab LC series. At ASMS, we unveiled our newest LC/MS Triple Quad, the Ultivo. It's not an exaggeration to say it's revolutionary. The Ultivo is 70% smaller than previous instruments, yet it still delivers the same or better performance than its predecessor. Our customers tell us that the Triple Quad is the workhorse of the lab. The Ultivo allows our customer to maximize their lab space and increase capacity without compromising performance or uptime. This revolutionary new instrument is a great example of Agilent's market expertise and commitment to customer-centric innovation. We also strengthened our GC/MS lineup with the introduction of a new high-resolution, accurate-mass system. This new product will help our customers address the growing demand for identification of unknown chemical samples. We look to buy businesses in fast-growing, adjacent market segments with differentiated offerings and strong teams. In July, we completed the acquisition of Cobalt Light Systems, adding Raman spectroscopy to our spectroscopy lineup. Cobalt Light Systems has developed ground-breaking technology that is integrated into an innovated suite of bench-top and handheld instruments. We are now directly participating in this fast-growing spectroscopy market segment. There are strong synergies between the 2 companies. We are scaling the operations at Cobalt Light Systems and will be offering our current customers these groundbreaking solutions. CrossLab, a key strategic move of a new Agilent, continues to pay off. The Agilent CrossLab Group maintained a strong performance again this quarter, with core revenue growth of 8%. Growth was robust for both services and consumables. The Diagnostics and Genomics Group also delivered strong core revenue growth of 8%. Results were driven by strong demand for our pathology products and companion diagnostic services. We see particular strength for our PD-L1 and molecular products. As I mentioned earlier, our Nucleic Acid Solutions business, which can be lumpy, performed well, and is up by very strong double digits. The growth we saw in our Pathology business is a strong sign that we are regaining market share, with our automation system, Omnis, and the new products we are continuing to introduce, from special stains to ready-to-use anti-body offerings, our Pathology division is creating a lot of momentum. We also introduced our newest next-generation sequencing library prep solution, Agilent SureSelectXT HS. This research solution benefits our customers by streamlining the entire NGS workflow. On the M&A front, we acquired the molecular and sample barcoding patent portfolios of Population Genetics Technologies. This expansion of our IP portfolio bolsters our target enrichment leadership position, enabling the future integration of new solutions to our customers. Rapid integration of the Multiplicom business continues to proceed according to plan. Let me close out my portion of the call recapping the journey of the new Agilent, and with some comments on our Q4 outlook. In May of 2015, at our first Analyst and Investor Day of the new Agilent, we laid out an ambitious 3-year plan to create shareholder value. We made 3 commitments: We committed to outgrow the market. We committed to improve adjusted operating margins over 400 basis points. We committed to take a balanced approach in deploying our capital. Over the past 10 quarters, we have been delivering on our commitments. I'm so proud of this team. We are on the cusp of achieving the goals that we set for ourselves. And we first shared with you over 2 years ago. We are a team that delivers on its commitments. I think it's now time retire the description "New Agilent." We have put in a new foundation for the company to grow, and we are firmly focused on the future. The achievement of these goals is just the beginning. Our story is a forward-looking story, with a laser focus on delivering superior earnings growth and creating shareholder value. Looking at the more immediate future, I want to close with a few comments about Q4, '17. First, we remain somewhat cautious about the potential for a cyclical recovery. We also know we're heading into period of tough compares for our global Pharma and China businesses. Yet, the overall market environment for Agilent is stronger than forecasted coming into this year. Given these considerations, we are once again raising our full year core growth and earnings expectations. I look forward to answering your questions later in the call, and will now hand off to Didier. Didier will provide additional insights on our Q3 results and updated guidance. Didier?

Thank you, Mike. And hello, everyone. As mentioned by Mike, we delivered strong top and bottom line results, both on a year-over-year basis and versus our guidance. Currency had a positive impact on revenue and operating profits of, respectively, $7 million and $1 million versus previous guidance. Please also note that we have reduced our pro forma tax rate by 1 percentage points, which had a $0.02 impact on our Q3 EPS. I'll now turn to the guidance for our fourth quarter. We expect Q4 revenues of $1.15 billion to $1.17 billion, and EPS of $0.60 to $0.62. At midpoint, revenue is expected to grow 3.5% on a core basis. As a reminder, our core revenue growth last Q4 was a strong 6.3%, so Q4 is a tough compare, coming after an easier Q3 compare. Versus previous guidance, currency is estimated to have a positive impact of $24 million on revenue and $4 million on operating profit. Finally, our 22.4% adjusted operating margin at midpoint will be 90 basis points -- will be up 90 basis points sequentially. Now to the guidance of fiscal year 2017. The Q4 guidance is expected to result in the following fiscal year guidance. First, at midpoint, revenue is projected to grow 6.0% on a core basis or 1 percentage point over the previous guidance. The revenue guidance or $4.445 billion is $75 million over the previous guidance, including $31 million due to currency and $1 million due to M&A. Second, our EPS guidance at $2.30 at midpoint is up $0.12 from previous guidance, and corresponds to a 16% year-over-year increase. Currency contributed $0.01, and the reduction in pro forma tax rate contributed $0.03. Third, adjusted operating margin for the year is expected to be 21.8% or 110 basis points higher than in fiscal year '16. And last but not the least, we have raised our operating cash flow guidance from $825 million to $850 million. And we have -- we are reducing our CapEx guidance from $200 million to $185 million. This leads to an increase in free cash flow guidance of $40 million. With that, I'll turn it over to Alicia for the Q&A.

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

[Operator Instructions] And our first question comes from Dan Arias from Citigroup.

Didier, in the DGG business, a bit of quarterly variation on the op margin line. Where do you think the op margin settle in if we just look out a bit maybe past the current year? Is there a range that you can kind of help us with there?

Yes, you're right. The DDG business can be little a bit lumpy on an operating margin basis for many, many reasons. What's important is that we came from -- we're coming from 13% operating margin in 2015 to 16% in 2016. And we are aiming still, as we have basically announced back 2 years ago, to close to 20% in 2017. So the ranch, I would say, after we complete this fiscal year, will be around the 20% that we've talked about. And Jacob, I don't know if you want to add anything.

No, I think that's absolutely correct.

Okay. And then, Mike, maybe just on Chemical & Energy, could you just put a little color to what you're seeing inside that business? Out of city unit as a whole is doing better. Just curious what the commentary on exploration sounds like at this point. Are you expecting to finish the year sort of on a similar note? Or are we seeing some pickup towards the fourth quarter?

Yes, sure. Dan. So maybe first of all, I want to reground maybe some of the segments, because I think probably last 5 or 6, 7 -- maybe 7 quarters, I would describe a certain breakdown of the Chemical & Energy along the lines of energy refining and in chemical. And as you know, we've been under -- the energy sector has been under a lot of pressure last 2 quarters. So right now, our estimates are that energy represents about 10% of the -- excuse me. Thank you, Patrick. Exploration, that got me mixed up here. Exploration represented about 10% of the total, while refining is about 30% and the chemical side is about 60%. So just to kind of ground yourself, there is less of our business now in the exploration side of the business. We actually expect that to continue to be down for the remainder of this year. So we're not really seeing much going on there. What we are seeing, that's why I put it into in my script, is that there's been a high emphasis on cash management and cash control in prior years. We're starting to see a little bit of money being freed up to focus on reinvestments. And really to drive productivity. In fact, I saw a recent article on Wall Street Journal talking about the importance of customers, companies driving towards increased earnings. So what that tells us is that energy, the exploration side of the segment, is going to continue to go down. We expect replacement to continue in the chemical side. We are still cautious on the refining side of the business. In fact, we have recently seen that the next 12 months EPS forecast for large cap refining, companies have declined since May. So it's not all going well in this segment. Overall, we're encouraged by the results. It's only 2 quarters of strong growth, so we're not yet ready to call a cyclical turnaround. But I would remind you that for the year, we're forecasting overall 8% growth for this Chemical & Energy segment. A much different result than we've seen in the prior 2 years. So hopefully that helps get answer to your question.

Our next question comes from Tim Evans from Wells Fargo Securities.

Mike, what's your general sense for how much of the strength you saw this quarter was overall in-market strength versus strength of some of the new products that you've launched?

Tim, thanks for the question. As you know, our whole model is built around outgrowing the market based on a real focus on innovation that matters to customers, tied to really a solid go-to-market channel. So I think what you've got going on [ for that ] is sort of a perfect storm, if you will, from a standpoint of, we're able to put up these very strong growth results because we have a highly competitive and differentiated portfolio. So we know we're gaining market share in a growing market. And that really leads to the kind of results that we're having here. So I know all CEOs claim to be gaining market share, but we look at the numbers. It seems to prove out for us.

Okay. And then, could you maybe just comment on the runway for CrossLab? Is that something where you still feel like there is multiple years of above-market growth?

Yes, I'll make some of initial opening comments here, Tim. Then I'll invite Mark to take a bow in terms of the results we've been pushing up here and talk about the future. So, as I commented in my script, this was a major strategic initiative for us to really go after this, what we see to be, a new market for us in CrossLab, to really think much broader about our offering in the lab and really to focus on enterprise services. And we think about the entire lab as our opportunity. We've had a number of quarters of very strong growth. And our view is that we can expect to see this growth continue. And I'd point out to you some of the markets, which historically haven't been big purchase of service, for example, really driving a lot of growth. For example, we had stellar results once again in China. So Mark, why don't you give your thoughts about the future of the CrossLab Group? And can you sustain this run here on?

Thanks, Mike. But let me elaborate a little bit on Mike's comments. And a lot of tension comes around our Enterprise Solutions (sic) [Enterprise Services] business. And that is a big factor behind our growth. However, want to peel that back a little bit. The Instrument service business is much larger, been growing at high-single digits, that's enabling workflows and certainly complementing a lot of the new product technologies we're bringing to market. And the consumables business is routinely growing in the mid- to high single-digit range, too. If I look ahead though, we see a very robust market for the enterprise business, in particular, in Pharma and increasingly inside the commercial labs that serve across multiple end markets, that can be environmental, food, et cetera. And I don't think there's any end in sight when it comes to the challenge of improving the productivity of the lab operations. And that's really where our value proposition is, is built upon versus single sourcing. Can we truly help you get the efficiency the lab going out? So very bullish about our runway in this business going forward. And I'd say it's more than just an enterprise service story. It's really about our instrument service business and our consumables rounding out the entire picture.

Our next question comes from Jack Meehan from Barclays.

Mike, I was hoping you can elaborate a little bit on the performance in biopharma in this quarter? Specifically, the trends you're seeing at U.S. Pharma? And then maybe just elaborate a little bit more on the commentary related to API and the offering there?

Let's start with -- the second question was? I'm sorry I missed that one.

Related to the commentary around the API offering.

Sorry about that, Jack. They say your hearing is one of the first things to go when you get older. Let me start with the biopharma comment, and then, Patrick, I'm going to have you jump in and give your view on the dimension by geography. But we're really pleased. Although we don't report externally the absolute results in the biopharma segment of the pharma market, we're really pleased with how this business is performing. As you may recall, this is a major strategic initiative that we launched probably about 2.5 years ago to really go after the biopharma market segment in a much different manner. We've been bringing to market a number of new novel solutions. We've changed our go-to-market strategy, and it's paying off. So what I can tell you is we grew double-digit in biopharma in the third quarter. We think we're outpacing the overall market. And perhaps, your view of mix by geography and then anything else you want to add, Patrick.

Yes, sure. Thanks, Mike. So we have seen a strong -- very, very strong growth in China. We have seen reasonable growth in EMEA, in Europe, and also would say single-digit growth in [ AFO ]. So that's the distribution on a regional level. And it's heavily driven, of course, by biopharma, as Mike mentioned because that is growing ahead of the [ biopharma ] space. But I would say if you look at the different segments in Pharma, it's on the R&D side, as well as manufacturing QA, QC, we are very well-represented there. And we don't see a real slowdown right now in the biopharma space. So looking forward, given the new portfolio we have. Also the focus on complete workflows that we launched over the last couple of months, we are pretty confident that we will continue to grow strong in this market and capture more share.

Thanks, Patrick. And Jacob, perhaps you can address Jack's question on the API?

Yes, so on the API side, the -- our Nucleic Acid Solutions division, we see a lot of great momentum in the business. And we continue to really be in a situation where capacity is our main constraint. So that's also why we, right now, as we explained before, we are building this new capacity -- manufacturing capacity out in Colorado in Boulder, to really make sure we can expand versus the demand that's out there. We have seen -- as it goes in this business, we did see a few quarters ago, that one of our customers did not meet the endpoint in a Phase III clinical trial. And that has led us to rebuild the pipeline. We have seen very strong demand, and we are really back in full swing again.

That's great. And then clearly a lot of new product launches coming on the mass spec side. I was wondering if you had any thoughts related to pushing mass spec into the clinical setting. A couple of your peers are pretty active there. I was wondering if that was a future target for Agilent as well.

Why don't you take that, Patrick...?

I'll take that one, Mike. Thank you. So we -- as you know, we are currently present in the LDG space. We launched Class 1 product several years ago. And this is a, what we see, as a sweet spot right now for LC/MS and clinical. It's really all about pain management, Vitamin D testing and all those applications, immunosuppressants, And we are pretty well represented in that space right now, whether it will be able to replace immunoassays, some of our competitors might think, we have some question marks there, we think we're pretty strong in LDG market that might continue. We see actually probably more promise on the more sophisticated assays that are related to metabolomics, and that are more related to space of cancer diagnostics and more complex diseases like Alzheimer's, a couple of years out. So this is where we see the focus for this business, because getting into a clinical workflow, where the [ riser-based ] assays are established and trying to blaze -- replace those will be quite difficult, I would say.

Our next question comes from Tycho Peterson from JPMorgan.

My question on maybe just a longer-term outlook on margins. Wondering if you could comment a little bit as we think about the framework for next year, could you get a similar level of margin improvement and are there levers whether it's pricing or improving R&D efficiency that you could kind of point to as we think about the margin setup for next year?

Thanks, Tyco. Appreciate the question. What I'll do is I'll refer you back to the messaging that we provided at our last AID. So what we committed to was greater than 22, as we move forward. And we think we've got a model which allows us to continue to improve our operating margin. But -- and it's going to be a combination of a number of things you mentioned already, which is innovation focus, making sure that we're pricing for value, they're managing our discounts correctly. So we have initiative underway we call the PDQ, a pricing and discounting quote initiative to really make sure that we're managing the price envelope correctly. The other thing I would point to is also the great work that our order fulfillment team has been doing. So when we formed the new company, we centralized all the manufacturing logistics and material procurement in one organization. And they've been doing a very nice job. And we think that the transformation that's underway in our supply chain [ could ] allow us to have some cost reductions in the future. So we won't commit today in the call to a specific number, but we like improving operating margins without sacrificing growth. That was my -- one of the key parts of my script, which says, hey, we're going to outgrow the market while improving operating margin. So that will continue to be our model. And as we look forward, and you can expect us to try to sustain levels of success we've enjoyed so far.

Okay. And then question on Intuvo, I understand you're generally not calling for cyclical Chemical & Energy recovery, but if we think about just the sales cycle, can you maybe talk as to how it's tracked versus initial expectations? How long are we going to have trialing systems? What would be the update?

Sure. Yes, glad to -- always happy to talk about Intuvo. And we also have the Ultivo. So it is getting a little -- can be a tongue twister at times. But, Patrick, why don't you update the callers on what's going on with Intuvo?

Yes, absolutely. So we're happy with the feedback that we received from the installed base. So of the instruments we have shipped so far, customers are really excited about the performance, robustness and ease of use of this product. That said, we are not still and not yet shipping any really big bulk orders. As we said in the calls in the last quarter and the quarter before is, we think it will happen more in fiscal year '18 when customers had enough time to test the instruments and also assign a budget to these instruments moving forward.

Yes, I think that was learning for us, Patrick, which was, we thought we had -- we were in sort of the window with a September launch. But we really -- what we found out from our customers, they really didn't have time to plan for this in their 2017 budget.

Absolutely. Actually, as you know, we launched in September last year, and the feedback we got from several large accounts was, well, very nice instruments. We have not yet -- we didn't have the time to really plan for the budget for fiscal year '17. But we are now getting feedback from those that's it's definitely in the budget for fiscal year '18. Again, the feedback is very positive. It is still early, in the ramp to volume of this product. But yes, really excited about the excitement it drives. Also, across the other cheesy products they have out there. We're clearly seen as the market leader in the gas chromatography and the go-to company.

Okay. And then just one last one on academics, you flagged Europe as being the driver there. Any comments on the U.S. market? Are budgets freeing up a little bit here from what you're seeing?

Yes, Tycho, when we looked at some of the numbers and talked about it as a team, we said, listen, what we're really seeing is, our growth, which was a nice surprise for us in the third quarter, really was a market share gain story. So we're still not seeing a lot of active funding going on in the marketplace. And I think U.S. still seems to be fairly subdued. And Patrick, I don't know what your thoughts on that, but I think we're not that bullish on the overall market environment. We do think we're able to pick up some growth here, given that historically we've been underrepresented in terms of share. But the market is still not very robust.

Agreed. Yes. Definitely, in the U.S. is not very robust. We have seen some upticks in Europe in the last quarter, which helped to drive growth. And we think we are very well positioned with our portfolio. We also have a dedicated program within the company to really look at our [indiscernible] model for Academia and Government. And as Mike said, it's all about taking market share from our competitors. And this is what we're after.

Yes, I think that's maybe something that I should have mentioned earlier, Tycho, as part of our channel strategy, changes were made when I came in as CEO, we really catered a dedicated focus on Academia and Government. So I think perhaps we're starting to see some payoff of those early investments now.

Our next question comes from Paul Knight from Janney Montgomery.

Can you talk about some of your initiatives that are developing like your oligo expansion? And also, my follow-up would be your thoughts on is Asia getting better or the same? Specifically, China.

Yes, thanks for that, Paul. Appreciate the congratulatory comments. I'll make sure that the team hears that. And relative to the oligo expansion, in fact, a few of us are heading out there tomorrow to see firsthand are we're seeing pictures of the building, but there's nothing like seeing it firsthand. So we have a -- going out and spend some time with the team. We're expanding into Frederick. The construction schedule is going right according to plan. I think, Jacob, we're looking probably look like more still FY '19 revenue.

That's correct.

2018, the factory will be done. But there'll be a validation process required. And the reason why I asked Jacob to talk about some of the customer activity is because we still see an incredible amount of demand for customers. And it's been a capacity constraint kind of growth challenge for us. But we're fully committed. We'll see firsthand, and maybe I'll have some more in-depth comments when I talk to you next. But the construction schedule and the go-to market is still on -- per plan. And then relative to China, and overall Asia, so I think about China, China continues to develop, just as we have forecasted. I think we're a little bit over double-digit through the first 3 quarters. We thought it would be a double-digit grower for us in 2017. We're seeing no signs of slowdown there. I think what has been a nice surprise is the other countries in Southeast Asia has been a very fast growing -- faster growing market for us. You may recall about a year ago, a lot of concerns about the impact of the currency outside of those countries. And inside Agilent, we call it SAPK, which is South Asia, Pacific and Korea, and we've been putting good growth up in that part of the sector, much higher than we had in prior years. I would say that Japan is the one where the market is still sluggish. Although, we've been able to have about a 6% growth rate over the last 2 quarters. But it's -- that's probably the most challenging of all the Asian markets we play in. I don't know whether you count India and Asia or not. It's managed in Agilent by our European team. But India market also continues to be quite strong. So I think Asia is going to continue to be a growth story. Not only for 2017, but into '18 as well.

What's your primary, most important element do you think behind your market share gains? Is it CrossLab? Or is it tuck-in potential situations like Cobalt?

I think it's really -- we are kind of -- if I step back from it, I think it's both a combination of how we've been able to broaden our portfolio, tied with a true customer focus. I know you hear it all the time. But we really try to think about what matters to our customers and then align our business strategies behind it. So we're not only doing great science and driving innovation with some of the new instrumentation that we've been inducing. But as we mentioned earlier, we're really helping our customers with, what we call, the economics of lab. And that's really the CrossLab. So I think it's -- we're getting share in both places. And I think it's been the combination of how we architected -- architected, if you will, our portfolio strategies. And I can't also overemphasize enough the importance of having the right go-to-customer sales model. We made some pretty big changes the first year, the new Agilent. And we're now, I think, starting to see the benefits of that, which is how it really tight set of customer relationships tied with a broadening portfolio with a much clearer economic value proposition via CrossLab.

And lastly, were there share repurchases in the quarter, Mike?

No, no.

Our next question comes from Puneet Souda from Leerink Partners.

Just -- on Dako, if I could ask. You know with the Omnis rollout happening here, and you mentioned Quest contract earlier in [indiscernible] Chemistry. Was that a contribution in the quarter? And how should we think about this pull-through from these boxes in the back half of the year once they start getting out there?

Yes, Puneet. Thanks a lot for the congratulatory comments. And I know Jacob would love to talk about the overall pathology results for the quarter. And then maybe, go in specifically to the question around of the impact of Quest and timing that we have on our business.

Yes, thanks for that. And we are very pleased with where we are with our Dako portfolio business today, where we really see a very strong momentum or continuous momentum with the business. Clearly, we were very pleased with the win of Quest being the primary vendor here. Which we announced, I think, it was last time. We are in the progress of installing our solutions on several Quest sites. So we haven't seen any contribution from Quest in this quarter. And we'll start to see it come in here next quarter. But it's primarily a fiscal '18 view or situation that we'll start to see Quest coming in. So right now, our pathology business is really driven by everything else we're doing out there. And Quest is just a part of the story. It's a great part of the story, but we do see strengthening in all parts of geographies right now.

Okay. Got it. And then, second one just the Pharma and growth. Obviously, it's strong in the quarter. So if you look at the Pharma CRO and the CDMO accounts, what's your sense of sustainability here? And what's it driving? Is it the biomolecules? I mean, I suppose they're using a number of products through the LSAG segment. What gives you the sense that these customers are continuing to see growth in biomolecules here, as we've heard from other -- few other competitors, there was lumpiness in that segment.

I know that some of our competitors reported that, but that's not what we experienced. And Patrick, you want to share your thoughts here?

No, I agree. This is not what we are seeing right now. And part of it is, again, the solutions we brought out. The new solutions that helped drive the business there that are really focused on the biopharma space. On monoclonal antibodies, there's also new software solutions out of there for biosimilars like our BioConfirm Software. So I think we're addressing the needs of this market space better and better, and that will drive for us more business moving forward. Especially, I think also the biosimilars is a market space that will continue to grow. And I don't expect a big slowdown in that area.

And just last quickly on China, are you still seeing benefit from the CFDA changes or this contribution? I mean, obviously, you have tougher comps coming up and your base is significantly larger in China. So what's your sense of CFDA changes continuing to benefit versus the food and environmental business?

Yes, thanks for that question. So we expect the food market to continue to be strong in China. We explicitly called that out. I think we used the word food market fundamentals remain strong. Growth rates actually are a little bit lower for China in Q3, just because we're coming out with 20-some percent compare from a prior year. But the money is there and the emphasis is there. It's a critical government policy to continue to improve the safety of their food supply. A lot of work it still to be done. So we're expecting the growth to be still be there.

Our next question comes from Dan Leonard from Deutsche Bank.

One question, I just want to dive into a little bit on detail on what you're seeing from one specific customer base within Pharma. So it seems like the generic industry is getting weaker and the challenges are worsening there, at least for some of the public companies. Are you seeing any of that in your customer base yet? Or any of that in the purchasing patterns?

What do you think, Patrick?

No. I mean, it's definitely not growing at the same pace as biopharma, as we outlined here. But it's still growing for us. And we don't see any material changes in the next couple of quarters. Yes, we will see tough compares because we have been growing so strong over the last 8 or 6 quarters or 7 quarters in Pharma. But the fundamental business in small molecule is also there.

Yes, and you have -- if you can show a return on investment, right? So I think that's been one of the selling propositions for the new portfolio.

Absolutely, absolutely.

When they're under pressure, generics guys, they're willing to invest because they can see it helps their earnings profile.

The whole messaging is around productivity and efficiency gains and the cost of ownership for resolutions and it resonates very well with this customer base.

I'll just add on. This is Mark. Obviously, with the Enterprise Solutions (sic) [Enterprise Services] business, I'd echo the same comments that Patrick and Mike have. We've seen the value proposition around the economics of the lab continue to resonate as they have more challenges.

That's helpful color. And then from my follow-up, as I think about the 3.5% core growth rate for the fourth quarter, that would be the lightest core growth in I think it's 4 or 5 quarters. And how much of that would you attribute to a tough comp versus maybe some caution on the end market versus just plain old conservatism?

So let me maybe add some color, then you can add your comments as well, Didier. So when we look at the comps, they're real. I haven't done the math in terms of the x percentage, but pharma is our largest market. It grew 16%, Q4 last year. China, which is our second largest geography, grew 27%. So the comp -- the tough compares are real and that's a part of our guiding philosophy all this year. We've been calling that business remains robust, but we know we're going into a period of tough compares. I would say, relative to the Chemical, Energy, what we're saying here is businesses going to be better than we initially thought it was going to be coming into this year. We're glad to see the strong growth in the last 2 quarters, but there's still some signs that say, let's not get too far ahead of ourselves here. We've had 40% of this segment is still under pressure. The company's earnings forecast are projected to be down. So we just think that it's right thing to be doing to not call for cyclical turnaround just yet. And Didier, I don't know if you would add anything else to our approach to looking at the quarter.

Maybe just that Europe, we had double-digit growth 2 quarters in a row. And we also want to be a little bit cautious about extrapolating that number. If last quarter we had told you where we are forecasting Europe to go 12% in Q3, I think, you have crucified us. So it's tough to just -- we don't want to extrapolate those kind of superb results for 2 quarters.

Our next question comes from Catherine Schulte from Robert W. Baird.

Can you elaborate a little bit more on the initial feedback on an uptick of Ultivo Triple Quad, and then just comment on your performance in LC/MS in general?

Yes, Catherine, be happy to. It's a great a question. And when your question came through, there was a smile on Patrick's face. So I know he's anxious to share a little more about what's going on with Ultivo.

Absolutely. So first, I mean, on the Ultivo question and then general view on LC/MS and GC/MS as well. We think Ultivo was really to star this year at ASMS. When we introduce the product, it creates a lot of excitement among our customers base. They cannot wait to get their hands on the prototype. That said, we will not ship anything before end of this quarter. So I don't expect any revenue contribution in Q4 by -- from coming from the Ultivo product itself. I think it would be very well positioned to ramp that product in fiscal year '18 and capture the market opportunity specifically in the environmental and food application space where this product is really front and center in terms of the specifications and the application domain. So lots of excitement around there, but it's not the only product we have launched at ASMS. We launched a new Infinity single-quad solution. We have the biopharma Q-TOF solution and we launched a new GC/Q-TOF solution that will all again drive the momentum behind our mass spectroscopy solutions. Very strong showing, and we are very optimistic about the future of this product line, the technologies and the focus we have and customer applications, as it creates a lot of excitement. And we see that also in the growth rates already in Q3.

All right. Great. And then I wanted to spend a little time on the Cobalt acquisition. Can you just walk us through your thought process there, revenue run rate and then what kind of growth you think you could get out of that business?

Sure, Catherine. So as I mentioned in the call, we really have been trying to find companies, which in adjacent markets would fill gaps in our current offerings, but also have a differentiated offering and a very strong team. And we've been trying to build out our spectroscopy business, with a lot of success over the last several years. The one hole was Raman spectroscopy, which is arguably one of the fastest-growing segments in spectroscopy. So we engage the Cobalt Light Systems team early. In fact, it's had a chance to spend some time with the leadership team here earlier today. And I don't think they're yet ready to move the next phase, but we got to them early, talk to them about joining the company, being part of Agilent, and they really saw advantages to scale and the innovation focus that Agilent has. It's a 50-person-plus company, about $10 million-plus run rate and we think that -- I think double-digit growth Patrick?

Yes. Given where the market is and the differentiated technology is, I think, we're definitely look for double-digit growth.

Our next question comes from Steve Beuchaw from Morgan Stanley.

I've got 2 for Jacob. One is as a follow-up on the SureSelect commentary, I wonder has the discussion around that product portfolio has become bigger from Agilent over the last couple of years, if you can give us a little bit more granularity. Can you give us a sense for maybe how big that business is? How fast it's growing? Are you taking share? Is it accelerating? Can you just talk about how the portfolio, including SureSelect and around SureSelect in library perhaps [ sample prep ] is contributing to the growth in DGG?

Yes, Steve, thanks, for that. And I'm very pleased with the new announcement of the SureSelectXT HS, which I think is going to really drive the business going forward. First of all, it would work very well with FFPE. And with the molecular barcodes, you would also see that we would be able to really get very certain in results on low leading frequencies. So I think this is exactly what the market is looking for. Overall, the SureSelect and I'll talk on this, investment business has been a success story for DGG and for genomics over last many years. It is a substantial part of genomics business, and it continues to grow in the double-digit regime. I think we have seen industry over last few quarters that the market has at least taken a little bit of a pause, but we still see double-digit growth of our business. So it is -- I think we still are definitely keeping our market share out in the business. I'm not sure right now whether we're taking market share, but we're certainly keeping it. And with the new SureSelectXT HS, I'm very convinced that we will start to see even stronger momentum again. I will say that SureSelect and where we're going with all this right now is our strategy is to become a whole workflow provider, where SureSelect is going to be a key part of that, and SureSelect is our entry into that market. So clearly it's very important for us going forward, but we are going to expand out both with the ELISA platform, our bioinformatics platform. But also with our Lasergen investments, we hope to be full workflow provider in the future.

That super helpful. The second thing I was hoping to get just a little color on is the Nucleic Acid Solutions market, the environment surrounding the investment in Colorado. On the last call, Mike, gave us an update on the progress there, we talked about the potential for that to be a more material contributor, the capacity expansion, for fiscal '19. Could you give us a sense for how big you think the relative opportunity is as compared to how much business you're doing out today and how much business are you just having to pass on because of that capacity constraint? And how fast does it ramp?

Yes, thanks, again, Stephen and I appreciate the interest in the NASD business, which is very exciting. Most of our customers today are still doing clinical trials. So there's a lot of investment and we continue to track the investment going into this market right now with this new type of drugs. And there is a continued increase investments and we are hopeful to see some of those clinical trials coming out into commercial products over the next few years here. And that will create a substantial step up in the -- both in the expectations and also the requirements to our capacity. So I see that this could take it quite far over next 10 years. I would say Pharma does not go as fast as diagnostic, but you would see some step-ups every time we see some products going out and be commercial. So related to our current business, I think they certainly have an opportunity to substantially have -- see a substantial growth going forward over the next 5 years and probably also next 10 years. Do you want to say more?

Yes, I'll just add one thing, Steve. Right now, the business is about $70 million, $80 million and we are capped. We are operating at maximum capacity. And as Mike and Jacob mentioned, the new capacity only comes on board in 2019. And will add about $100 million after it's full running state. So the ramp will be throughout fiscal year '19. So fiscal year '20, we're talking about $100 million, just with that additional business, but 2018 will be relatively flat with 2017 because we are already at capacity of existing facility.

Our next question comes from Brandon Couillard from Jefferies.

Mike, just a question on the M&A high-level, how you see the pipeline? And if you could sort of elaborate on exactly what the Population Genetics deal does for you strategically and economically?

Sure, Brandon. I'm happy to address both questions. And then relative to M&A, we still see that there's a pretty robust pipeline of targets out there, but not in the historic places where people have focused on in the U.S. public sector. There's a lot of very, very strong companies in Europe in the private sector as well as in the U.S. And you may recall that in May, we had a new head of strategy and business development joined Agilent. And one of the priorities there is related to continue to find ways to make M&A more of a growth platform within the overall operating model. We have to continue to describe [ for us ] in terms of how we want to use our cash and our balance sheet strength. I would say valuations are a little rich. So we have to be -- make sure you don't get too far ahead of yourself in terms of what you're willing to pay. But I think that there are viable targets out there, particularly for a company of Agilent's size, where we can acquire companies and they really can make a meaningful impact possibly in terms of our ability to grow. The recent IP that we purchased -- why don't you talk a little bit about the strategic thought process, Jacob, and the financials around it?

Yes, absolutely. And the Population Genetics, Pop Gen, is, as Mike was mentioning, an IP consideration. And we're very pleased to have that which creates a very strong IP situation within molecular barcodes. But we see a very strong interest for molecular barcodes where we think this is going to be very important is, first and foremost, in liquid biopsies. But secondly also for what we'll call eliminating false-positive that you see in NGS right now and especially going into the Dx, the diagnostic markets where you need to make sure that what you measure is actually fully related to or correlated to actually the sample you have in there and using those molecular barcodes ensures that you are very certain of what you measure is actually also there. So I believe actually that molecular barcodes is going to be required to really have a play in the diagnostic setting going forward. And so I think we will be in a very strong position to really drive that market.

One more for Didier. In terms of the CapEx outlook, the $15 million reduction, was that a pushout into '19 or, excuse me, '18. And as far as next year goes, should we still expect a return to a normal level of CapEx, call it, around $110 million, $120 million for next year?

Yes, it is indeed a pushout into '18, but you will see '18 will be lower than the number that we've just quoted for '17. So we are returning to a more normal stage in '18, but mostly it will be in '19.

Our next question comes from Doug Schenkel from Cowen.

I want to touch on 2 topics, 2 loose ends. The first is tax. You reduce your full year tax rate guidance. You're on track to get to an 18% non-GAAP tax rate level, well ahead of your prior expectations. Should we expect further tax rate reductions towards your -- something like your much lower cash tax rate moving forward, and if you could quantify anything there, it would be helpful? The second topic is on end markets and guidance. I was hoping that you'd be willing to share your assumptions for growth by end market and geography at least as they're embedded into your Q4 revenue growth guidance.

Want to take the first?

Sure. Yes, Doug -- yes, I mean, you rightly pointed out that our -- a new pro forma tax rate of 18% is way above our cash tax rate, which is less than 10%. So we do have -- see opportunities basically. It's hard work. I'm not ready to commit now to like Mike did not commit to a precise operating margin expansion number. I'm not ready to commit yet to precise path. But yes, there's more opportunities. And we're working hard to identify ways to reduce our reserves, so that we can move closer to -- I mean, move our pro forma tax rate down. And it's a -- stay posted.

You want me take the next one?

Yes, please.

Yes. So I think if you look at our full year guidance, Doug, a 6% core growth for the overall enterprise, we expect China to be right around 10% or so for the year. Overall, Asia around double-digit with mid-single-digit growth in Europe as well as Americas. So again, the Europe -- the Asia side of the business is expected to be the growth engine, although all geographies are expected to grow for us this year. And then when I look at the -- finally, I know it's relative to the -- there you can help me. Thanks, Alicia. When you look at the end market, again, the same 6% core growth. Here, what we're seeing is, Chemical & Energy, I think 7%, 8% range, I think, is what we've been talking, about 8% for the year. As I mentioned earlier, some caveats, still there are some segments, which still have some question marks. We've been very consistent with our view that the pharma with the -- would go from it's a double-digit grower that we had in '16 to more high single digits. So you're probably looking at 8-ish for Pharma for the full year, flat for Academia and Government, and then high single digits for Diagnostic and Clinical and then food, Environmental, Forensics, low single digits. So the story here is...

Our next question comes from Derik De Bruin from Bank of America Merrill Lynch.

All right. So Doug just took my questions. So I now got to be creative. So...

You think fast on your feet, Derik, so whatever you say is fine.

So can we talk a little bit about pacing during the quarter? I mean, you do have an extra month relative to some of your peers on this. Was July any different than May or June? I mean, you notice any signs of potential unusual seasonality showing in the quarter?

I think you know, Derik, we don't explicitly talk about our incoming orders in terms of where we finish, but what I can tell is Q3 was like any other Q3 we've seen. So nothing really special about it, besides the fact that it was an excellent quarter for the company.

Okay. And when you look at your Pharma business, I mean, we've had a lot of questions about generic exposure, and how much of your business is actually tied to the generics manufacturers in your Pharma segment?

I don't have a good number on my head on that one, Patrick.

Generics is probably difficult to answer. I would say small molecule overall raises biopharma...

85-15, right?

80-20, you could say.

80-20?

Yes.

80-20 small molecule or 80-20 biopharma?

80% small molecule and 20% bio -- biomolecule.

Great. And just -- I'm just sort of looking at the numbers...

I thought 3 questions. You're already on your third question. "I have no questions.

I'm not as dumb as I look. So -- the -- I'll leave it at that. So you did 6% core growth in '15, 6% in '16, you're tracking to 6% this year, given a conservative Q4 guide, is -- and we sort of look at the business and just sort of given where the segments are, I mean, are there -- is a mid-single-digit sort of [ core ] growth rate on the business for next year is certainly a reasonable number to sort of think about as we started thinking about expectations?

So I'm going to kind of give a little kind of a teaser for our November call. So I'll hold the guide for November call. Didier is giving me hand signals on that one right now. But I think what you can see a consistent message is our ability -- our model is all about outgrowing the market. So I think that's what you look for us to do and like I said earlier, we really -- we're retiring "The New Agilent", the name. We arrived, we got a foundation and the model that's gotten us here, we're going to stay with that model, but if you can just wait a few more months, I'll have much more clear answer to your question.

Our next question comes from Isaac Ro from Goldman Sachs.

I wanted to come back to the industrial portion of the business and I think you covered some of the backdrop on Energy, but interested in what went on in Chemical this quarter. Just talk a little bit about not just the growth rate but also kind of your outlook for the rest of the fiscal year, obviously, the commodity dynamic here remains a little volatile. So I'm interested in the Chemical side of your business and how you're managing through that.

Happy to, Isaac. Just a reminder, we're now going to be talking about a different ratio of the 3 segments that make up the Chemical & Energy space, given the climb we've seen over the last 2 years in exploration side. So exploration is about 10%, refining is about 30%. So, if you will, the Energy sector is about 40%. The other 60% is, in what we call, chemicals and materials. And that's really been what the growth we're seeing has been coming from. Some reinvestment in refining side, but mostly growth has been on the chemical and material side. What we're seeing is for the year, we're forecasting, as I mentioned earlier to Doug's question -- or say, listen, we think we'll probably do 8% or so for the year in Chemical & Energy, which is remarkable turnaround, given the fact that the prior 2 years actually had shrunk for us. But I can't emphasize enough that there still are signs of caution. You may want to use the word conservatism, but I'll just say I'm just trying to be very pragmatic and think about what's going on here. And we're saying, listen, 2 good quarters of growth. Okay, great. Let's see how the next quarter shapes up and I keep coming get back to 40% of that segment is still under pressure and our major customers here, those companies themselves have seen a downgrade in their earnings forecast for the next 12 months. So all in all, a much better picture than we thought coming into the year, but still some reason to be a little bit pragmatic in terms of how we view the future growth in Q4 and beyond.

Okay. And maybe just second question would be on the DGG segment, since you guys didn't do your annual investor meeting this year, I was hoping for a bit of a long-term refresh on the strategy, obviously you've had good success with the Dako asset, you spent some time talking about SureSelect, and you've got obviously a lot of other investments and irons in the fire for NGS. But putting that altogether, how should we think about your appetite to invest strategically and organically in DGG relative to the rest of the company? I mean, it seems like there's good opportunity to add into -- to fill into the more whitespace, and I'm curious how high a priority that is?

Yes, it's -- we have a very large appetite in the space. And a number of things have been happening. So if you look, Jacob has done a really excellent job in terms of addressing the fundamentals of the business, pathology business was double-digit growth for us. When I first came on this role, a lot of questions about the future of the Dako acquisition. We've got that on. [Audio Gap] We're in the solid growth there. And we are making a number of significant investments, both organically and inorganically. So a lot of our M&A has been focused in this area. So whether it'd be the Cartagenia acquisition, the Multiplicom acquisition, Lasergen, equity investment, the recent Pop Gen, so we have a lot of interest in this space. And as I mentioned earlier, not to put any pressure on Sam, who happens to be in the room with me, but we brought in a new Head of Strategy and Corporate Development, and really from the space, so we're very interested in finding new ways for Agilent to grow in the space. We'd like the fundamentals of the market, and we like our ability to take a bigger piece of that market.

Got it. And just last question there, just given the -- it's your smallest segment and the end market opportunities there are pretty vast. Should we assume that will remain the highest growth segment in the company for the foreseeable future? And I'm just trying to put that all in context on the numbers.

Well, I think all 3 group presidents are fighting now to see who can grow the fastest. So we think all of our business groups can grow, I think that the rest of them really unique fundamentals going on in DGG space, which perhaps has a higher long-term inherent growth rate than some of our other markets. So we think we're all going to be winners, and maybe perhaps a little bit higher growth ultimately in DGG.

And I'm showing no further questions from our phone lines. I would now like to turn the conference back over to Alicia Rodriguez for any closing remarks.

Thank you, Crystal. On behalf of the management team, I'd like to thank everybody for joining us today. If you have any questions, please give us a call in Investor Relations, and I'd like to wish you a good rest of the day and thank you again. Bye-bye.

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