Agilent Technologies' (A) CEO Mike McMullen on Q4 2016 Results - Earnings Call Transcript

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Agilent Technologies Inc. (NYSE:A)

Q4 2016 Earnings Conference Call

November 15, 2016 4:30 PM ET

Executives

Alicia Rodriguez - VP, IR

Mike McMullen - President and CEO

Didier Hirsch - SVP and CFO

Patrick Kaltenbach - President of Agilent’s Life Sciences and Applied Markets Group

Jacob Thaysen - President of Agilent’s Diagnostics and Genomics Group

Mark Doak - President of the Agilent CrossLab Group.

Analysts

Steve Beuchaw - Morgan Stanley

Tycho Peterson - JPMorgan

Luke Lynch - Evercore ISI

Ryan Blicker - Cowen and Company

Jonathan Groberg - UBS

Derik de Bruin - Bank of America

Paul Knight - Janney

Jack Meehan - Barclays

Isaac Ro - Goldman Sachs

Brandon Couillard - Jefferies

Dan Arias - Citigroup

Puneet Souda - Leerink Partners

Operator

Good day, ladies and gentlemen, and welcome to the Agilent Technologies Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s program is being recorded.

I would now like to hand the floor over to Alicia Rodriguez, Vice President of Investor Relations. Please go ahead.

Alicia Rodriguez

Thank you, Karen, and welcome everyone to Agilent’s fourth quarter conference call for fiscal year 2016. With me are Mike McMullen, Agilent’s President and CEO; and Didier Hirsch, Agilent’s Senior Vice President and CFO. Joining in the Q&A after Didier’s comments will be Patrick Kaltenbach, President of Agilent’s Life Sciences and Applied Markets Group; Jacob Thaysen, President of Agilent’s Diagnostics and Genomics Group; and Mark Doak, President of the Agilent CrossLab Group.

You can find the press release and information to supplement today’s discussion on our website at www.investor.agilent.com. While there, please click on the link for financial results under the Financial Information tab, you 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.

Mike McMullen

Thanks, Alicia, and hello everyone. I am 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 first surprised by the strength of our instrument business in pharma, China and Europe, which far exceeds our expectation.

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 fiscal 2015. Turning to our full year results, core revenue continued to outperform the market, growing 5.9%, we increased our operating margins 110 basis points to 20.7% from 2015. These results show a 14% increase in adjusted earnings per share for the full year.

We're 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 a $150 million in cash dividend, repurchased $434 million of our shares and invested 480 million directly into the business through M&A, strategic transactions and capital expenditures.

Let me now address what's happened in our end markets and business group. 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 has been 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 U.S. government investments continue to lag 2015 spending levels.

Critical 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 Americas. China also drove growth in environmental market up 3%. Chemical energy declined 3% in line with expectations due to continued 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 lead 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 were stable with Q3. Japan and Americas were flat with growth constrained by continued chemical-energy market weakness and specific to the U.S. low U.S. government funding.

Moving onto the business groups, life science and applied markets group delivered core revenue growth of 5%. And expected revenues from our analytical lab instrument business, was driven by an attractive combination of introducing new products into growing markets. This applied in particular to our new line up 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're building for the future; in August, we introduced the transformational Intuvo 9000 GC system. Building on a recognized GC leadership, the Intuvo system revolutionized the way users performed gas chromatography. Industry experts recognized the unique innovation being delivered by Agilent with press coverage at 100% positive. Intuvo was 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 uptick in revenue. Limited international shipments are expected in Q1 of fiscal 2017 with volumes expected to increase over subsequent quarters. Another industry unique product, the Agilent 8900 Triple Quad ICPMS System which we just introduced in Q3 has also been well received in the market. This instrument is rapidly becoming the solution of choice in lab to demand the highest standard 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 was also driven by strong pharma, food, clinical and diagnostic markets, where our cross lab customer value proposition is being well received.

Unlike our instrument business ACG also grew in the chemical and energy markets. Laboratory supporting strong production levels drove demand for consumables. There is also continued demand for services as customers focus on keeping their order instruments operational. We are investing for the future in ACG, we just introduced a new range that 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 continue to successfully integrate the recently acquired iLab business which brings differentiated capabilities to core lab Manager's.

Last, but certainly not least in terms of impact, the momentum in the diagnostic Genomics Group continued with delivery of 8% core growth. Our laser focus on improvement previous acquired Dako business is paying off. The pathology business continues its steady climb back to market growth rates with strong and strengthen reagents and companion diagnostics. Our new clinic asset solutions business for which we recently announced a significant production capacity grew double digit.

This growth reflects the 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 the 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 from metastatic non-small cell lung cancers of patients with high rates of PD-L1 expression.

In conjunction, Agilent's pharmDx companion diagnostics PD-L1 test is now approved for expanding use. This is the first time in 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 the comprehensive offering of poor crystal libraries for functional genomics. This was held accelerate research in the complex diseases and drug discovery. We signed an agreement with Burning Rock Biotech to develop cancer diagnostics in China based on Agilent's SureSelect. Solutions, and we broke background initiated construction on the announced our $120 million investments in a new factory in Colorado to expand nucleic acid production capacity.

Turning now to operating margin, we remained focus on operating margins improvements. Since the Agilent leadership team was appointed, we have delivered seven consecutive quarters of improved operating margin and strong growth. Despite continued challenges in the chemical 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 synergy cost due the spinoff of key site.

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, improved our interactions with customers and lowered our costs. It is having an impact and will continue to deliver savings in 2017 and beyond. In the coming year, we've realized 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 fiscal year 2017 marketing and company outlook. As a reminder, our shareholder value creation model for a superior earnings growth is throughout go to market and expand operating margins with a balanced deployment of our capital. Didier will go to the specifics of our Q1 2017 and full year guidance; I want to share our thinking about end markets and our initial guidance philosophy given the environment of increased uncertainty. This is a change since 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 around European markets. We are forecasting moderate growth in the U.S., with U.S. government policies and spending, and Chemical and Energy markets being the wild cards.

Chemical and 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 U.S. elections play out. We are also keeping a watchful eye on how potential new U.S. government driven trade and currency valuation discussions could impact our business.

We finished fiscal 2016 very strongly, and we are well-positioned for future growth with a rich pipeline of new offerings. In our initial revenue guidance for 2017, however, we want to be on the cautious side. We want to see more clarity on U.S. 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 strengthens us well for the coming year and 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 adjusting operating margins by 280 basis points over the past two years -- and our march to improved operating margins will continue in 2017. However, in our initial operating margin and earnings per share guidance for fiscal 2017, we want to be on the cautious side.

Since our May Analyst and Investor day meeting, changes in exchange rates, pension expenses and the recent iLab acquisition are having a short-term dilutive impact on our operating margins of 0.5 percent. The Agilent team, however, is laser-focused on improving another 130 basis points of operating margin. We have internal action plans aligned with achieving a 22% operating margin goal in fiscal 2017, 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 program has and will continue to deliver incremental improvements in operating margins. 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 deliver future growth.

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

Didier Hirsch

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 OM, adjusted for income from Keysight, was up 60 bps and 110 bps 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 2 cents impact on our EPS.

Our operating cash flow for the full year at $793 million reflects our strong overall performance. 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 will now turn to the guidance for Fiscal Year 2017 As Mike stated, our initial guidance, like last year, assumes what we believe to be appropriate caution. Our fiscal year 17 revenue guidance of $4.35 billion to $4.37 billion corresponds to a core revenue growth of 4.0 % to 4.5%. It is based on October 31st exchange rates and currency has a 0.6% negative impact on revenues.

We project fiscal year 17 adjusted operation margin of 21% to 21.5% and fiscal year 17 EPS of $2.10 to $2.16, growing 8% at midpoint. As you update your models for fiscal year 17, 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. As we front-load 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. Four, depreciation is projected to be $104 million for the fiscal year. Fifth, the non-GAAP effective tax rate is projected to remain at 19%. Six, 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.

Seven, we plan to borrow $250 million in the second half to fund a portion of our capital returns. Eight, net interest expense is forecasted at $71 million and other income at $11 million. Nine, for purpose of our EPS guidance, we have assumed a diluted share count of 324 million, 5 million less than the average diluted share count in fiscal year 16. And finally, tenth, we expect operating cash flow of $825 million and capital expenditures of $200 million, about $60 million over fiscal year 16, mostly due to the investment in a second nucleic acid facility.

Now, finally, moving to the guidance for our first quarter. First, please note that Lunar New Year falls in Q1 this year, versus Q2 last year, meaning about $15 million of revenues 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%. As customary, Q1 EPS is negatively impacted by the December salary increase, front-loading of stock-based compensation, and the increase in payroll taxes due to the disbursement of the variable and incentive pay of the previous year.

With that, I will turn it over to Alicia for the Q&A

Alicia Rodriguez

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Steve Beuchaw from Morgan Stanley.

Steve Beuchaw

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?

Mike McMullen

Thanks, Steve. The headline for me was as we looked throughout the quarter, we were winning more business than we planned. So, we win a lot of business in our core market. I think some of the end markets strengths that we planned to was actually a 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 in government environment. And for us, I think we were just delighted by our performance in particular in our analytical instrument business where we seemed to be winning more business than we planned, and that we think that those well for the strength of our portfolio and so other things we've been doing over the last year in our channels as well.

Steve Beuchaw

And then so the follow-up I guess just to dig a little deeper would be did you notice anything in terms instrument trends relative to consumable trends accelerating a decelerating and what is that telling you about end of calendar year budget flash. Thank so much.

Mike McMullen

Yes, we were talking a bit about this yesterday with the team. And if you look at our performance to the quarter, we got off to a strong start in August and continued throughout the quarter. And sometime it's hard to tell other first month where things are lamped for the quarter. But I'd say by the end of September, we knew we are letting more business than we planned. There is really shaping up to be strong quarter for us and really position us well for us going into 2017.

Operator

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

Tycho Peterson

Mike, just hoping for a little bit more color on some of the expectations in guidance particularly in pharma. Are you still assuming that's kind of double-digit growth next year or are you factoring in a moderation? And on environment you've managed to grow that business in contrast what we saw from one of your peers last week. So may be talk a little bit about you know contribution from the GC replacement type for next year as well?

Mike McMullen

Yes, sure. 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 in place in 2016. So, 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 comparisons and Didier, if I remember correctly, we were in the mid to high single digit growth for pharma.

Didier Hirsch

Yes.

Mike McMullen

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

Tycho Peterson

Yes, the GC replacement cycle.

Mike McMullen

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 prospect of that market and I think we got kind of a perfect storm here going on where we have strong products going into 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 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 withs these companies about what they may get in terms of funding in 2017. What are your thoughts, Patrick, on that as well?

Patrick Kaltenbach

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 management, 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 where we had discussions overtime not only in Intuvo, but I think what in Intuvo launched it for us, it also spread the lot of discussion again about of other part of portfolio to 70 to 90 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 their productivity, driving their cost analysis down. And this is where we are exceptionally well positioned to this portfolio.

Mike McMullen

Yes, maybe just to put an exclamation point on this is that we know that the installed base is that historic levels of ageing. We know the equipments being used and it's just the matter of time for that replacement cycle is going to turn on, but as you saw in my call comments, we're not ready to call that yet.

Tycho Peterson

Okay. And then just as one clarification on the operating margin guidance half of the cut your down by 1% from where you talked about the Analyst Day half that is for my lab tension at FX. Is that rest just conservatism even kind of the macro?

Mike McMullen

Actually, I think where we had, was high end guidance around 21.5, right. Didier?

Didier Hirsch

Yes, with the high end is at 21.5 and we are losing about 50 basis points related to the three items that's we had mentioned currently acquisition and pension expenses. And the other thing that to note is as Mike has clearly stated that we have fielding measured on achieving 22% in terms of our variable conversation.

Mike McMullen

Yes, in the way Didier talked about this one was listen, we think we got to pass to 22, but there is lot higher risk than there was back at the last call and at the May AID. So, we thought it was prudent for us to guide this way, but we rollout inside while our comp is tied to the 22% number.

Didier Hirsch

The three are elements that where your headwinds.

Operator

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

Luke Lynch

Hi, guys. This is Luke Lynch for Ross. Just 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?

Mike McMullen

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.

Didier Hirsch

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 related to operating leverage and some of it related to the continuation of our Agile Agilent Program.

Mike McMullen

And maybe reminding the audience, Didier, when we first started this march almost two years ago to go to the 22%, we laid out a path which is 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.

Luke Lynch

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

Mike McMullen

So, I assume when you refer to timing impact, you're referring to special I mean between 2016 and 2017, some cash outlays or inlays that could --

Luke Lynch

Yes, correct.

Didier Hirsch

Yes, there's a little bit. Let me just highlight two potentially. In fiscal year 2016, 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 had 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 to 91 so an increased capital cash outlay.

And then second we did not fund our U.S. pension plan in 2016 so our overall contributions to our worldwide pension plan was $24 million. We intend to fund our U.S. pension plan more in 2017 and contributions to the pension plan will move to 45, so an increase from 24 to 45. 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 year-over-year basis. And your second question?

Luke Lynch

Related to tax rates.

Didier Hirsch

Yes, the tax rates, I -did mention at the May Analyst Day that we were going to work really hard on the reducing our tax rate by 2 percentage points over the course of next two to three years. We're very happy to be able to deliver already 1 percentage point in this fiscal year '16. We still aiming to reduce our effective tax rate by about 1 percentage point over the course of next 24 months, as committed to -- or indicated I would say in fiscal year -- in the AID but it's prudent to assume that the reduction will come in fiscal year '18 and not in fiscal year '17. So, in your models, we advise you to put a 1 percentage point reduction in tax rate from '19 to '18, in fiscal year '18, not in fiscal year '17.

Luke Lynch

Does that include the FASB 21609 benefit?

Didier Hirsch

It includes everything.

Operator

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

Ryan Blicker

Hi, this is Ryan Blicker on for Doug. Thanks for taking my questions. Would you be willing to provide what your LTMS 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?

Mike McMullen

What I can tell you is that back to my earlier statement is we're winning more business than planned. So we're quite pleased with how we've been doing with the LCMS portfolio and Patrick you may want to remind the audience some of the new stuff that we've come out with. So, I guess I'm not comfortable with giving the specifics of the growth rate, but just give you a sense of trend of the business and maybe a few proof points why we believe as it's going as well as it is.

Patrick Kaltenbach

Sure. Again, we are confident that we are outgrowing the market on many fronts. We have a very strong LTMS 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 LCMS is important and then we think both are wining 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 that is also in line with what's probably have heard from some of our competitors, but overall, we have been very pleased with the result in Q4.

Ryan Blicker

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.

Mike McMullen

Sure, Ryan. Didier, how about I make a few initial comments and if you want to add anything to it. But first 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. But, obviously, we would welcome this type of development including a move to a more permanent reduction in U.S. corporate tax rates. That being said, I think if you go beyond the theory, we assume 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 U.S. 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. But I think what we'd want to do is first of all understand what are the restriction that's could be tied to it. Also remind the group that some of the cash does need to remain. If that particular situation would develop we would 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 U.S. based M&A or stock repurchases. I guess you must be okay with that, Didier. You haven't said anything else.

Didier Hirsch

We are just waiting for his baited breath for the fine lines on any chance, but yes.

Operator

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

Jonathan Groberg

Thanks. Mike, so, I was just going back and looking. You did 6% growth organically 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 to slowdown year-over-year?

Mike McMullen

Yes, great question, John, and thanks for that. And obviously, we spent a lot of time talking about, this is a team and I mentioned to Alicia before the call I think we may be the first company in our space with had a new guidance after the U.S elections. So, what I am going to tell you is kind of factors we are thinking about and then also give you may be some 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 a multitude of factors that we need to pay attention to regulatory market.

What's going to happen to our customers in the food markets, environmental markets, the FDA regulatory markets? So, we know there is going to be a customer impact. What's going to happen with U.S. government funding? A lot of our business is driven by U.S. government funding. What's going to happen in the trade agreements? There has been a lot of noise about Chinese currency. We just talked about the tax and more of the M&A environment change in terms of. So, I can say right now Jonathan is perhaps like everybody else on this call, we kind of as a sense of the issues, but we don’t know which way these things are go yet. So, we are not going to call them.

And that's one of the reasons why we took what we believe to be a prudent cautious initial guide to FY '17. If I look at the end market, I mean pharma is going to continue to be strong, but we don’t believe that it can continue to grow double-digits throughout all of place FY '17. So, we've tapered down our expectations to bit about pharma. We also think that China has been just fantastic for us. I think our number of the year was 21% growth for the year. I am dialing that back a bit to double-digits. So what we are 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 comparison some market that really have been driving to business.

As I mentioned to you, the wildcard is the term on energy. One of the thing you pointed out Jonathan and what's I am really delighted is, we've had 6% 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 growth, so -- but I've learned over the first two years in this job, it's really hard to call turns of the major markets. So, I'm not going to and we're just kind of keeping eye on it and will update you as we go through the year. But that's our thinking about how our view in the U.S. elections and thus far behind our end market guidance for next year.

Jonathan Groberg

Thanks, and if I could just one more on the diagnostic and clinical market?

Mike McMullen

Yes, Jacob Thaysen will answer a question.

Jonathan Groberg

Yes, so obviously whether you have 8% growth there, obviously you're probably going to say it's too early to think about how hospitals may react to the potential repeal of ACA. But although the PD-L1 testing business, how much of your growth was driven by that market and can you size that market for us yet?

Jacob Thaysen

Well, it's I can start by saying that we have been very pleased with the performance of the PD-L1 over the last 12. I think its 13 months now and it has been growing, it's not to our expectation then above even, and we expect that to continue to grow by now based on Keytruda going first line; and obviously now with all companion diagnostic, we would see a bigger demand for U.S. in Europe and in other regions. The market itself is very difficult to size as you know that both been the companion with one drug and then has been into complimentary with another drug and those have very different concise at this point of time.

I still believe that the overall PD-L1 market might end up in the same size at the HER2 market, but the difference is that HER2 was only one, basically one drug, one glass of drug together with one diagnostics where that the PD-L1 will be up to five different drugs and maybe more, and then five different diagnostic maybe even for a lot of indications also. So, this is as closest I can get to right now, and the market we placed in is that the two companion diagnostics that we have today continue to grow strongly. I won't say that's the overall acting driver for the 8% basically all our businesses today have their very nice close performance, but it's definitely contributing.

Operator

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

Derik de Bruin

The pace in the quarter was very good. Can you talk a little bit about backlog and I guess did you pulled, are you ready to pull anything for the first quarter and I mean any unusual spending patterns that you though?

Mike McMullen

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 comment about quarters or backlog, but I did say in earlier comments that we are well positioned for 2017. I would ask you to think about the Q1 particularly the impact of Chinese Lunar New Year. I told, Didier, he said I don’t want to talk about it in the Q1 call. So, let's make sure that we included 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 will probably push about a week's worth of revenue or so from Q1 and Q2 because customers just won't be there to take delivery and as you saw all the growth rates have been really exceptional for us in China.

Derik de Bruin

I appreciate the New Years' comments. I am just going to follow that up with another question. Are you -- have you had any conversation with your customer that I mean obviously you're not the only trying to figure out what the new world order 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 beginning of the year as people trying to get their arms around what exactly with the administration have in store?

Mike McMullen

No, actually we don’t have that concern. What we've been more thinking about as where the things going on long term. So, but in the next quarter, we don’t have any real concern about that. And that's why we are going our full year guidance here in November, and it's 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.

Operator

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

Unidentified Analyst

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

Mike McMullen

Hi, Bill, how are you?

Unidentified Analyst

Doing well. May be just touching on China again, could you may be talk about what your underlying trends have been driving the outsized growth for the Company? Is it bio pharma? Is it food? Is it environmental? And how does that impact as you look to next year? Thanks.

Mike McMullen

Thanks for the question. I have to say really it was across the Board with one exception which is the chemical and energy of market. So, all the other markets were up quite substantially for us and I think this is consistent with what we had talked about in prior call, which is really there is going to be a level of investment in China relative to quality of life issues and environmental, and food lined directly with their five year plan that they were in midst of a major improvement in overall pharma industry, and that there is a lot of money going into to research.

And then, I think the reason Agilent has been able to do so well here as we got this combination of we've working reorganization structure, our China model in the country, we've had a lot of stability over the last 18 months. So, we got a really strong team there and that combinations of the team are historical strength in China and the new products we have. It's all coming together in terms of growth and I guess let me just add one thing and Mark perhaps you can comment on here. We often talk about the strength of end market and the new products going to this end markets, but I think there is something going on relative to your business there and the move to service is I think worth common as well.

Mark Doak

Thanks, Mike, and thanks Bill to add little color to that as we've seen a fundamental shift in buying behaviors in China largely shifting from the core areas at around Shanghai, Beijing, to some of the more tier 2, tier 3 cities where services now is viewed as the common place purchasing item in China. And that's certainly driving the growth, but the breath of services is I think in China as well as the consumable business now is the rest the story, where they have reached the size and scale that they have the same interest that we find in the western market, around the enterprise services and consumable all coming together. So, starting as you mentioned Mike with our extraordinarily strong position to start with, the installed base of China is just allowed us to build the business and truly outgrow our expectations in the second half around this too.

Mike McMullen

Yes, I mentioned, I asked market to comment on that because as you may recall, we really have changed the portfolio composition of the Company much more in the aftermarkets. So, CapEx instruments are actually less than 50% now with total Company's revenue. And historically China has been driven by new instrument purchases. We're seeing increasing growth also come in services and consumables.

Unidentified Analyst

And then just a follow up for Didier on the guidance, CapEx about 200 million this year, could you maybe just talk about where the incremental dollars are going and maybe what do you think the maintenance CapEx is for as one as a whole?

Didier Hirsch

The main reason for the increase which is about $60 million from 139 this year to 200 next year is really the significant increase that we're planning in terms of our nucleic acid facility RNA-based therapeutics and in Colorado. So, we had one facility, we're still expanding the capacity of that facility, but we're building and we've just started few weeks ago; 20 miles away a second facility that will kind of double the capacity when it'll be put in production end of 2018, 2019. So, that is the main reason for the increase and 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. So, this is way above our run rate.

Operator

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

Jack Meehan

I wanted to follow up on the diagnostics business really thought it was a nice quarter on a tough comp. Maybe you talk about the PL-1, but just any more the focus on the Omnis and just whether you think you're picking up steam in the 2017 and anything worth watching on the reimbursement side with that?

Mike McMullen

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

Jacob Thaysen

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, and it continues to -- basically, it continues to increase over, during '16. So, with that momentum we expect that we will continue to see a good performance into '17 also. From the reimbursement perspective obviously there're already some expectations how that would look like into '17 and '18, with the Pama [ph] and so on. But now we'll have to see what happens under the new administration here, where that would change anything. But so far, we actually don't expect any significant changes into '17.

Jack Meehan

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

Mike McMullen

I mean, 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 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 the water fulfillment team. I think you may have heard me speak previously about some of our work in the value engineering, material cost, reduction in logistics; so I think I also would keep an eye on gross margins as we work through the year. Some of the things take a while to actually start coming through your P&L, but once they're there they're there for an extended period of time. Didier, anything else do you want to add to that?

Didier Hirsch

No, I mean, I mean we do have stretch goals as we mentioned, we are paid internally on the achieving 22% and that means all of us have stretched goals to make, to achieve that, to contribute to 22%, and OSS and there is Henrik, the order fulfillment on supply channel organization which has delivered greatly in '16 is looking at opportunities to deliver even more in '17, which would help us bridge the gap.

Mike McMullen

Yes. Thanks, Didier, and one additional though here as I think it's important to remind everyone is that some of the things are going to help in '17 have already been finished in '16. So, things such as our simplification of our financial systems infrastructures, so it's done, and now the statement would show up in '17.

Operator

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

Isaac Ro

First, question is quickly on the quarter. Curious, if you can comment on pacing, you guys have the off cycle calendar there with October, I am sure everyone curious is whether it was on the capital spending side or any particular end market you thought a meaningful acceleration or deceleration in the month of October? I think you said that pertains other rest of the calendar year?

Mike McMullen

No, Isaac, I just mentioned that what we saw was really strong pacing throughout the quarter, so wasn't -- we didn't see something happened all in sudden in the last four or five weeks. We had strength all through three quarters of our fiscal year close.

Isaac Ro

Got it. Thank you. And then may be a longer term question Mike regarding management incentives. You guys have spent a lot of time over the last couple of years taking about the emphasis on hitting on your margin goals and you guys have done that pretty well. So, as you moved pass that 22% number, I was wondering how you think about evolving incentive structure for the management team? And should we assume that the types of incentives you have in place have been placed maybe with slightly different targets? Or could you overall composition evolve a little bit here?

Mike McMullen

Isaac, it's a great question and I would point back to what we discussed back at the May AID where we really said, but this is really all about is generating superior earnings growth, right. So, if you think about what we are trying to do here is we are trying to outgrow the market, expanding operation margin to keep driving up our adjusted earnings per share growth.

So what we'd 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 your growth of market are 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 view as a company who grows their earnings faster than revenue.

But as I mentioned, the AID is I really want to also make sure that, we don’t get so focus on continue to drive up the operating margin the year in and year out, that you pass something that immediately to say accretive, may be the dilutive on your margins but with good M&A additions to the business. So, I think the way we're going to talk about the Company post '17 is very consistent with what we had talked about back in the spring in New York City.

Operator

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

Brandon Couillard

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

Mike McMullen

Sure, Brandon, as we look through my notes here, I think we're expecting low-single digit growth. And I think it's important to kind of parse it out by academia in government. So, we think to go by the major regions right, China is going to be strong. And they've actually helped to mitigate some of that's been happening in the U.S. 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 that the chemical energy market, which is kind of struggling 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 us, what they're going to do as a result of Brexit for those things. So, we expect the strong China academic government, we expect the continuation of this current environment in Europe. In United States, the academia side is not bad. It's, what we've seen more it's been on the U.S. government side. The U.S. government, our U.S. government business is down in 2016 relative to 2015. And that's why in my call I mentioned, we need to kind of see where this new administration goes with its budget plans and investment priority. So, right now, we're kind of standing at the side line as same as it's going to continue to be just like it is, but in the United States, but we could see something different in the few months, we just don’t know.

Operator

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

Dan Arias

Mike, just following up on the outlook. How are you thinking about the pacing of growth in chemical and energy in 2017, as the assumption that you kind of see some sequential improvement through the year or you basically flat lining to the business across the quarters just given that we haven’t seen much in the way of positive signals?

Mike McMullen

I think you anticipated my answer, so we basically have flat line for the year. And it's been shrinking for last seven or eight quarters, 2% or 3% I think we ended up down about 3% for the full year, and we're basically seeing it's going to be flattish for 2017. If there is any good news to that story as these fundamental industries are still out there in terms of gasoline is being produced, we've seen record levels production in United States. For example, the plants are running, there is lot of discussion, there is lot of report externally about a turn, Oil prices have been inching up.

But our history is 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 of 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.

Dan Arias

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 out margin guidance and just what you might look to do this year how at risk is the current out margin outlook from additional M&A? I mean 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 of the current forecast? Thanks.

Mike McMullen

I think what we said; I am really trying to be having actions that consistent with our prior communications. We said, we would look at acquisition that could be short-term dilutive in nature. And we did one in latter part of '16 when we just love having at last part of portfolio. It's a great addition to the business, but right now it's not that corporate average. We will move it up, so if we saw the opportunities like that we would pursue them. But I think if you want to look at type of the deals and the size and other things, just look at what we've done so far. To give you the kind of a sense of the things that we're looking at point forward, we like accretive deals and we like one that can move up move with move the margins up.

Operator

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

Puneet Souda

Just quick follow-up, if I could on the pharma and just wanted to understand there is clearly a solid contribution here. If you could maybe help us parse out, is that more coming from service small molecules and macro molecules? Or is this, are we thinking about them directly? Maybe we should be thinking about in terms of the service contract share that you're gaining via the CrossLab Group? Help us if you could parse that out a little bit.

Mike McMullen

Sure. So, there is something going on which is in terms of the overall fundamental end market growth rates, we think bio pharma in the small molecule side of pharma both growing quite strongly. Small molecule side is really being drive by a conversion to the new technologies of liquid chromatography in particular, also an increasing interest in enterprise service what we have to offer from ACG. So, I think that's being going on here for Agilent. We've had a combination of the really strong end market growth.

There is a new market that has and will continue to develop in this services side, and we are doing well there along with our new instruments in the pharma. When I look at '17, we think that the biopharma side of that market is going to continue to go quite strongly within an area of prioritization for us in terms of new solutions. But we do think that overtime that the small molecule will start to move back towards more of a long-term growth rate. And Patrick, I think would we kind of think about a long-term growth rates in this small molecule side.

Patrick Kaltenbach

Well, on the small molecule side, I think the more and low-to mid single-digits range whereas in bio pharma, we are more optimistic and it continues to be double digits, that's our projection right now.

Puneet Souda

All right. Thank you for that. Just one more in terms of the chemical energy markets, I mean we get the view into 2017, but as you have conversation with the labs and lab directors, so just help us understand. How they are thinking about capital equipment and 2017 knowing this times and knowing that the progression that's been? Or are they thinking more in 2018 terms on the capital equipment?

Mike McMullen

I have to say, I don’t think they really know yet as well. What they are doing right now is they're right in the midst of their capital budgeting process. So, what I can tell you is as I've had a couple of conversation with customers over the last two or three weeks on this exact topic. And what they described for me is, hey, these are one customer was somebody who provides services into equipment into the energy market. So listen, we are starting to get interest in quotes. But we are not sure where that's going to hit in '17 or '18. When we had our VIP launch for the Intuvo 9000 GC, a lot of customers from energy had listened. 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. And maybe I'll be able to get this improve this year or maybe the following year because there still seems to be the sentiment particularly with the larger companies, they want to hold on to the equipment as long as they can before they have replaced. And so again, that's why I pointed to the fact that's not all negative because of the fact that we do have a strong service in 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'll be a replenishment of aged equipment, but again we're just not confident enough right now to say when that's going to occur.

Operator

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.

Alicia Rodriguez

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 the call at IR. Appreciate it very much. Bye-bye.

Operator

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.

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