Alicia Rodriguez - VP, IR Michael McMullen - CEO, President and Director Didier Hirsch - CFO and SVP Mark Doak - SVP and President, Agilent CrossLab Group Jacob Thaysen - SVP and President, Diagnostics & Genomics Group Patrick Kaltenbach - SVP and President, Life Sciences & Applied Markets Group (LSAG) Business Unit.

Joel Kaufman - Goldman Sachs Group Mike Sarcone - Deutsche Bank Tycho Peterson - JPMorgan Chase Stephen Beuchaw - Morgan Stanley Samuel Couillard - Jefferies Douglas Schenkel - Cowen and Company Luke Sergott - Evercore ISI Derik De Bruin - Bank of America Merrill Lynch Puneet Souda - Leerink Partners Jack Meehan - Barclays Daniel Arias - Citigroup Sara Silverman - Wells Fargo Securities William March - Janney Montgomery Scott Catherine Schulte - Robert W.

Baird.

Good day, ladies and gentlemen, and welcome to the Agilent Technologies Second Quarter 2017 Earnings Conference Call. [Operator Instructions]. I would now like to turn the floor over to Alicia Rodriguez, Vice President of Investor Relations. Please go ahead..

Thank you, Karen, and welcome, everyone, to Agilent's second 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 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 growth -- 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 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, and hello, everyone. I'm very pleased to announce that the Agilent team delivered another excellent quarter with both revenue and earnings well above the high end of our guidance. We continue to deliver above market growth.

Revenues of $1.10 billion exceeded the high end of our February guidance by $42 million and are up 9% on a core basis. Our adjusted EPS of $0.58 is $0.09 above the high end of our guidance. Adjusted EPS is up 32% over the second quarter of last year. We delivered an adjusted operating margin of 22.1%, up 270 basis points from a year ago.

This is our ninth quarter in a row of improving operating margins. Let's now take a closer look at the better-than-expected Q2 performance. The story for the quarter are growth well above expectations in the chemical and energy, pharma and European markets, while our Asia business remains strong.

The lead story was the stronger-than-expected pickup in the chemical and energy market with 14% core growth. This comes on the heels of return to modest growth last quarter after 7 consecutive prior quarters of decline.

What's driving this higher-than-expected growth in our chemical and energy business? While the exploration segment remains challenged, the growth is broad-based across all geographies and product categories, particularly gas chromatography, spectroscopy and aftermarket services and consumables.

Chemical and refining customers are increasing their CapEx purchases. Our customers in material and mining segments have also started reinvesting after a prolonged period of declining sales. Core growth in pharma, 12% against a difficult compare, also exceeded expectations.

Demand continues across our pharma spectrum with highest growth in the biopharma segments and our NASD business. We are seeing strong customer interest in our new offerings and across our portfolio.

Our broad and differentiated opportunities in chromatography, spectroscopy, mass spectrometry, services and chemistries well position us to capitalize on a strong pharma demand. A few other end market comments. Our food business was up 1% against a difficult compare of 25% core growth last year. Food market fundamentals remained sound.

Environmental and forensics were up 7% on the strength in the Americas and Europe. As expected, academia and government market funding conditions remained weak, with our business down 2% for the quarter. Geographically, Europe exceeded our expectations with 10% core growth.

Except for academia and government, European growth was across all market segments with particular strength in the applied markets. Asia growth remains strong at 10%, with China delivering high single-digit growth against last year's growth of nearly 40% and in line with our expectations. Let's now turn to specifics for our business group.

The Life Sciences and Applied Markets Group delivered core revenue growth of 6%. Growth was led by higher-than-expected strength in chemical energy, pharma and environmental. From a product perspective, performance were broad-based across the portfolio with strength in chromatography, mass spectrometry, spectroscopy and cell analysis.

We continue to strengthen our instrumentation solutions portfolio. In large, we introduced the 6495B Triple Quadrupole LC/MS system. This new offering provides greater sensitivity and accuracy for applications such as food safety and environmental testing.

We also added to our portfolio of solutions in biopharma with the introduction of the Agilent 6545XT AdvanceBio LC/Q-TOF MS system. This system optimizes results for scientists seeking to characterize biomolecules that could be the basis for new therapies.

As we continue to see the external recognition of innovation and market leadership, at Pittcon 2017, Agilent won 2 prestigious Scientist Choice Awards, including Best New Separation Product of 2016 for the 1260 Infinity II LC system and Best Webinar Series of 2016 for our series on solutions and biopharmaceutical discovery and development.

At the Annual Conference of China Scientific Instruments, the gasoline Intuvo 9000 Gas Chromatograph System was selected as the Green Product of the Year and the Agilent 5977B GC/MS system won for the Most Popular Scientific Instrument.

At this same China conference for the second year in a row, Agilent was recognized as the most influential foreign manufacturer. Our pipeline of new products are strong, and we're looking forward to the upcoming ASMS Conference on their latest innovations from Agilent.

The Agilent CrossLab's group's strong performance continues with core revenue growth of 10%, well distributed across most regions and end markets. Our enterprise services and consumables growth was standout for the quarter.

Finally, the Diagnostics and Genomics group delivered core revenue growth of 13% while driving improvements in our operating margin. Growth was broad-based across pathology, companion diagnostics with particularly strong growth through our nucleic acid, CDMO business. We continue to bring compelling new offerings to our customers.

We introduced a new Target Enrichment Solution for next-generation DNA sequencing, Agilent SureSelect Clinical Research Exome V2. This solution delivers more than 1,000 additional disease-relevant targets compared to earlier version. We introduced Agilent's first CGH assay for diagnostic use, the GenetiSure Dx Postnatal Assay.

This assay will enable to detect genetic anomalies earlier and more accurately than traditional methods. In a significant win, Agilent was named the primary IHC and special stains vendor for Quest Diagnostics. This is a testament to the advantage of our standing workflow solution.

As a reminder, the integration of the former Dako business under Agilent's systems was completed in Q1, and we're starting to see the bottom line benefits of more streamlined cost structure.

We are in the early phase of integrating the Multiplicom acquisition into Agilent and even more excited to have the Agilent Multiplicom team to be part of Agilent. Coming off the strong start to 2017 in the past 2 quarters, how are we thinking about the coming quarters? Let's start with our lead story for the quarter, the chemical and energy market.

We are pleased to see two consecutive quarters now of growth in the chemical and energy market. However, it is early, and we're not yet ready to call a cyclical recovery. We do remain confident in our ability to capture market share in this market segment irrespective of market conditions.

We are the recognized leader in this space with an increasingly strong value proposition for our customers. Looking ahead at our other end markets, with the exception of the academia and government markets, we see solid market conditions for the pharma, food, environmental and clinical and diagnostics market.

Specific to Parma, investment levels remained strong, but we do expect some declining growth rates due to increasingly difficult compares. And a few additional comments on academia and government. We are expecting a continued weak funding environment across most geographies with the exception of China. In the United States, recent approval of the U.S.

Federal budgets through September is an encouraging sign, but we've not set -- we have not yet seen funds being released. Geographically, we expect the U.S. and China to grow consistent with prior expectations, while the growth trajectory in Europe is uncertain.

The outlook for Europe is highly dependent on the macroeconomic environment continuing to improve. We do not expect European government and academia spending to improve, and we are taking a wait-and-see approach on the European chemical and energy market, both major contributors to overall European performance.

These cautions aside, we are excited about the company's growth prospects and the steps we are taking to position the company for future growth. We are raising our full year core revenue growth and earnings expectations. Didier will share the details later in our call. Before I turn the call over to Didier, let me close with a few comments.

Q2 '17 marked the 2-year anniversary of this Agilent leadership team being put in place and the full initiation of our company-wide transformation initiatives.

Over 2 years ago, we outlined a path to increase shareholder value that was focused on outgrowing the market, expanding operating margins on an organic basis and deploying capital in a balanced manner. We have delivered on our shareholder commitments every quarter since then.

We have continue to outgrow the market and increase profitability each quarter often in challenging and economic circumstances. We have improved operating margins by 300 basis points during this period with a company-wide drive for continued profitability improvements.

During the same period, we deployed our capital in a balanced manner with acquisitions and strategic investments of $547 million, cash dividends of $334 million and share repurchase of $889 million. Behind these results are an energized Agilent team with a relentless commitment to customers.

In our Agilent DNA is our team's ability to drive customer-focused innovation coupled with operational excellence. It is this powerful combination that will continue to fuel our future growth and earnings expansion. 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 Q2 results and updated guidance.

Didier?.

Thank you, Mike, and hello, everyone. As Mike stated, we delivered another strong performance this quarter, 9% core revenue growth, 270 basis points of operating margin expansion, 32% EPS growth and $257 million in operating cash flow even after contributing $25 million to our U.S. pension plan.

The revenue performance drove most of the operating margin and EPS performance. During the quarter, we bought back 1.64 million shares of Agilent stock at an average price of $50.60 and paid $43 million in dividends. I will now turn to the guidance for our third quarter. We expect Q3 revenues of $1.06 billion to $1.08 billion and EPS of $0.49 to $0.51.

At midpoint, revenue will grow 4% on a core basis. As Mike stated, at this stage, we are not ready yet to call a cyclical recovery that assumes the sustainability of Q2's strong chemical and energy and European markets. Now to the guidance of fiscal year 2017.

We are raising the midpoint of our revenue guidance by $30 million, including $10 million due to currency. Thus, we're increasing our core revenue growth guidance at midpoint from 4.5% to 5%. We're also raising the midpoint of our EPS guidance by $0.05 including about $0.005 coming from FX.

There is no chance to operating cash flow guidance of $825 million and CapEx guidance of $200 million. With that, I'll turn it over to Alicia for the Q&A..

Thank you, Didier.

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

[Operator Instructions]. Our first question comes from the line of Isaac Ro with Goldman Sachs..

It's actually Joel in for Isaac. Appreciate all the chemical and energy end market color you guys provided.

But just from a company-specific perspective, could you maybe quantify how much the Intuvo 9000 product cycle contributed to the organic growth this quarter?.

How about I make a few comments about our gas chromatography business and I'll turn it over on to some specifics on the Intuvo GC launch? So in -- we know the very strong performance in the chemical and energy as well as environmental market for the company in Q2, and a contributor of that was the performance of our gas chromatography business, high single-digit growth we saw in gas chromatography mainly through our 7890 core product line.

As you know, we've indicated in previous calls that Intuvo will take some time to ramp and that we were expecting to be a more material impact on the company's P&L as we went into the latter parts of this year into FY '18.

So perhaps, you can give a little color, though, Patrick, on how the Intuvo launch has actually come along and how customers respond to the offering..

Okay, yes. Thank you, Mike. And so we are very happy with the launch. We have seen exciting feedback from our first customers out there. That said, we are still in the ramp phase with the product. We are still placing a lot of demo units out there.

The product is quite different into use -- user interface, et cetera, in used model compared to our standard product of 7890. We have put a lot of emphasis on usability, ease-of-use. So customers really want to touch and see it first before they make a buying decision. And as I said, the feedback is very positive so far from the customers we have seen.

We are ramping the product. It has not been a significant contributor to revenues this quarter yet, but we are very confident that we have a real winning product in our hands here, and it will make a more significant impact in the quarters to come. So we are, I would say, bullish on the outlook.

But for this quarter, it was not a very significant contributor yet..

Very helpful.

And then in the context of the revenue and earnings upside we've seen throughout the first half of the year, are there any R&D programs or maybe channel investments that you guys are accelerating into the back half of the year?.

I'd say we've been really pretty much staying on our plan on record so -- which, as you know, has been to invest at a higher level on the average in the industry and R&D.

And I think I've been pretty transparent in some prior calls that we also were building a lot -- adding a lot more a channel coverage and specialization, particularly in such areas such as biopharma. So I think we're just tracking to the plan. And as we said, we were delighted by the Q2 revenue results..

And our next question comes from the line of Dan Leonard with Deutsche Bank..

This is Mike Sarcone in for Dan Leonard. So another question on the chemical and energy end market. I think you mentioned that exploration remains challenged.

So does that mean you did see an improvement on the refining side in the energy segment? And can you just elaborate on that and as well as the chemical performance?.

Sure, happy to. So now just as a reminder for the audience, when we look at our chemical and energy market segmentation, historically, about 15% of our business has been in exploration. And I'd say that continues to be down very strongly, so no signs of real life there at all.

The other 35% of the total is in the refining area, and we have started to see some levels of reinvestment in the refining. And then also in the chemical side, which makes up the other 50%, we've seen investments starting up there again. Inconclusive in the space, we also report our sales into the mining and materials segments.

So I'd say the 85% of the segment shows signs of life, though not yet ready to call a full cyclical recovery. The other 15% in exploration remains down..

And if I could just pivot to biopharma. It seemed like through the quarter, end market performance diverged geographically for some of your peers or other tools players with exposure to the end market. And by that, I mean, there's also some underperformance in North America.

Did you see any of that in your biopharma business?.

No, no. Not at all. We saw a strong performance across all geographies, and one of the things that -- and no real notable difference in terms of relative to our expectations.

One thing I did try to note in the earnings call was the broad-based nature of our portfolio, which allows us to really capture a lot of the demand there beyond, say, liquid chromatography or mass spectrometry..

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

Mike, just trying to get our arms around the guidance here. You're calling for 4% core in 3Q against an easier comp after doing 9% this quarter.

Is there something that would lead to maybe some extra conservatism in the quarter ahead?.

Thanks, Tycho. So I'll leave the characterization to our guidance to you. But what I can do share with you is this thinking. I think there really are just 2 major watch areas for us, and why we're not -- and it really is the chemical energy, which, as you know, we put up a 14% growth after low single digits first quarter.

So we'd like to see another quarter or 2 of that to see whether or not it's sustained. And then on Europe, Europe was 10% growth for us, which, as you know, coming this year, we were quite concerned. Again, we want to see if the economic environment continues to improve there.

But we're just sort of taking a watch and see in both these areas as opposed to calling in type of sustained double-digit growth in these areas. What I would say is there's no hidden kind of concerns behind our guidance that we haven't been already discussing..

Okay. And then for a follow-up on DDG. Obviously, good quarter there. We saw good standing numbers out of Roche as well. Is there something going on in the end market in terms of improvement there? And can you also talk on the operating margin increase? That was certainly notable..

I'm sitting right next to Jacob here in the conference room. I know he's delighted to talk about his double-digit growth and his 20-plus percent operating profit performance.

So how do I pass it over to you, Jacob?.

Yes, thanks, Mike. And certainly, we had a great quarter. And you're also right that our portfolio business continues to provide momentum. And you're also right that we see competitive -- the competition also have good performance.

From our perspective, we continue to see good momentum from both our Omnis business, so advance same portfolio, but also including the PD-L1, which continues to drive momentum. I don't think we see a shift in the industry right now. One quarter is not making the business. We see more over a longer period of time.

But I don't think that we see that because 2 competitors have strong quarter that this is a change in the market environment. But we continue to see overall pathology is a strong market to be in..

And our next question comes from the line of Steve Beuchaw from Morgan Stanley..

So I'll actually start picking up on a point, I think, Tycho was alluding to, which is on margins. Didier, could you just give us a sense for what the drop-through looks like on incremental revenue in a quarter like this so we can think about how to fine tune our models best? And then as a follow-up, and it's somewhat related.

Mike, you had some experience now of seeing the performance of the commercial team since you integrated the sales force, and you've had a chance to take advantage of the breadth that you have in a refined service offering.

I mean, how are you thinking about deploying those learnings as you see the results coming through, putting the gas pedal down maybe a little bit more? How does that make you think about the rate of OpEx growth for this business as you see the returns on these investments?.

Yes. And how about I start there? Didier, you can go back to the margin question. Thanks for the question, Steve. And Didier and I have been talking a bit about the future modeling of the company, and obviously, we'll share more details with you later on in the year as we move into FY '18.

But as you know, we've been really working down our SG&A levels when we first started the company. I mean, we had a lot of restructuring and consolidation, and we had a significant amount of cost savings. We have been -- and then what we tried to do from there was take the cost out and then invest based on the revenue growth.

So we would expect to see the SG&A grow lower than -- and then revenue as we move forward. We've done a lot of build outs in the lot of the channel. I would tell you, though, there are some things we still like to continue to build out. The academia and government for one is one of the area where we're not yet at a leadership position.

So we do have some things on the drawing board where we like to have some additional incremental investments relative to today's level of resourcing. But I think you'll kind of see us stay with the same fundamental model of not cranking up these numbers as a percentage of revenue..

And on your other question, Steve. The -- so we continue having exceptional drop-through operating margin incrementals. We've enjoyed 56% for the whole year last year. I think we had a 47% in Q1. And this quarter, we had 56% similar to what we've basically enjoyed in the last 6 quarters.

So excellent drop-through., obviously, in part leading to the 9% core revenue growth..

And I think it's worth adding here, Didier, which is how we manage the company, right? So listen, we're not going to shortchange investments, which we think we can do relative to R&D and channels for future growth. But at the same point in time, we are going to be disciplined with our spending.

And I think you'll see that's how we've been managing the company, and that's why we've been able to get some of these margins up for the overall company performance..

I appreciate all the color there. Just one detail point for me, and then I'll let others jump in. It has to do with the expansion of the plant in Colorado, the oligonucleotide capacity expansion.

I wonder if we could get an update there on how that process is going and how we might think about the timing on when that incremental capacity could be a driver, contribution at the topline..

Yes, it's actually a very timely question because Didier and I just review with Jacob and the team the progress on the construction. And if you happen to find yourself on Frederick County, we can give you the address. You can drive by and wave to the construction crew there. But construction is proceeding as planned, right on target.

And we got through the winter months without a lot of any kind of major disruptions to our construction. And from a -- as you know, this is a pretty complex manufacturing facility. In fact, this will be sort of a one-of-a-kind in the industry given the amount of capacity that we're adding.

And then it also requires a level of validation required on the site. So long story. Short of it, I think you should think about this as being an FY '19 revenue impact for the company. We do believe that we can continue to get strong growth in our current facility.

But as you know, we're going to run out of capacity, so we're looking to bring that online in early FY '19..

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

Mike, a question for you.

I mean, with 85% of the chemical and energy business trending positively, I mean, what do you want to see before feeling more comfortable calling a bottom there? And any chance you could give us an update on what's embedded in your full year outlook for core growth for that segment?.

Sure. So part of it is tied to the macro view of a cyclical industrial recovery, and I don't think I'd add comments to there yet as well, so it'd be nice to have some external validation. And then from an Agilent perspective, I like to see another quarter or 2.

My first year in the job, I can remember getting a little overly enthusiastic about a turn in the chemical and energy, and I was only off by 6 or 7 quarters when we first started seeing growth again. So having sort of learned my lesson, I'm a little bit more cautious about when to call the downturn -- I mean, the upturn, excuse me.

Listen, we'll take the business, but I think I'll need another quarter or 2, and then give me a little bit of the external validation from some of the economists. And I think we're looking at, Alicia, for....

5%..

About 5%, right? About 5% for the year..

Okay. Super. And then one more 2-part question, though. You hired a new SVP of Strategy and Corporate Development in March, I believe. Anything to comment there in terms of your near-term M&A appetite? And then one for Didier. It looks like you took buybacks out of the second half of the year.

Any signal or messaging you're trying to share with us there?.

Yes. So first of all, Brandon, thanks a lot for the close watching of the company, and we're delighted to have Sam Raha on the Agilent executive team. Sam is actually here in the conference room with us as well.

And in terms of the M&A appetite, I think you're seeing that we are quite interested in adding new capabilities to the company in fast-growing spaces, and we've done 4 M&A deals already. One was a strategic investment in Lasergen. We feel a lot of interesting assets out there, particularly in the private space.

And given Sam's experience in analyzing industry, we think this allow us to perhaps have an increased level of velocity working through targets. So I think our appetite remains the same, but what we're doing is bringing on additional strong capability to help us through that process. And then I'll pass this over to you, Didier..

Yes, Brandon, on the buyback, you have a good eye. We have a very disciplined approach to our buyback program. Once a year in November, we register a 10b5-1, and the approach is both formulaic and opportunistic, which means that we are able to flex our buybacks according, obviously, to market conditions.

And the one thing that I would also mention is that this is not a program where you don't use it, you lose it. Any amount that is below what we plan to spend in a quarter is carried over to the next quarter and on and on if needs be.

So with that -- last -- we felt it was more cautious with the valuations of the market that we do not forecast the buyback because there is a cap. There is no doubt. The cap was raised 13%. Last time, we raised 8% in November, and we will certainly raise it again as we register the next buyback in a few months' time.

But we don't know what we don't know, and based on the potential market valuations in that, we decided that for the second half, it was better not to assume any buyback. And obviously, we don't -- we will see what happens..

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

My first question is on China. Just some clean-up there.

What was growth in the quarter? Anything interesting to call out by end market? And did the timing of Lunar New Year play any role it and strength in the quarter in China?.

Great. Always happy to share some insights on the -- on China. In terms of our overall growth, high single digits for the quarter. I think the most thing -- most important thing to note is the compare against the 40%, almost a 40% growth rate, on the prior year.

The end market demand continues to be quite healthy there, and we're still on our view that this can be -- this will be a low double-digit growth country for us in 2017. So no change at all in terms of the fundamentals, which remains strong. And to your point about Lunar New Year, really no impact.

So it's nice not to be talking about that in an earnings call as a reason for difference in performance. So things are really looking good in China. The market fundamentals are intact there, and we're really quite pleased with the performance of the company, and we're right on our earlier start of the year expectations of growth for China..

Okay. And not to beat a dead horse here, but I just want to push you a bit more on guidance. What -- you're guiding the third quarter, as it's been noted, to a moderation against the most favorable comps of the year. And then when you look ahead to Q4, your guidance implies the lowest growth rates since, I think, the first half of 2014.

I mean, that just doesn't make a ton of sense based on what we're hearing from you across the board.

Either something isn't going as well as it seems, which sure doesn't seem to be the case, or it seems like, at this point after 6 quarters of guiding the levels that are well below what you actually put up that, if we're going to be kind of intellectually honest about what's going on with the business that we should be modeling something a lot higher than what you're guiding to.

So with all that in mind, I just want to make sure, they were -- there was nothing in terms of the cadence in the quarter or any timing dynamics that came into play that shaped how you're guiding with the second half of the year..

So let me make two comments here then, Didier, feel free to add anything to that. But first of all, relative to anything that -- I forget exactly the terminology is. But anything that could be negative or significantly going wrong with the business, that's, by no means, the case here.

So the fundamentals of this company are very sound as well as the end markets. The point I, perhaps, will belabor if you don't mind is with my experience holding a turn 2 years ago in the chemical and energy market. I called it too early, and it never happened. In fact, we drove along for 5 or 6 quarters.

We also know that the European market, particularly in the summer months, is not always the strongest. So those are two things that we were watching, and that's the reason why we've guided the way we want -- we've done for the second half.

By the way, I think our core growth guidance guide for the year is, I think, perhaps at the upper end or higher than any of our peers. So we're already moving out our core growth rate for the year higher than everybody else in our space.

But based on our product experience in watching Europe and calling for a turn, a sustained turn in the chemical energy, I was wrong before, so I want to make sure I got it right this time, so we'll give it a few more quarters.

Didier, anything else you'd add to that?.

Well, maybe two things. Number one, on chemical and energy, basically, our revenue this quarter was a lot based on the year-end budget flush that -- in terms of orders that we saw among our customers and, perhaps, the beginning of the year. So we don't know how to really read it and if it is sustainable or not for that reason.

It's very much related to the end of last year's budget and beginning of this year's budget, and they might not be totally relevant data points. We'll see. And maybe the other thing is that a testament to the great work that our teams have done in terms of converting orders into revenue. I mean, we've done a fantastic job.

The patent order and also -- of orders also has improved tremendously with a lot more orders coming into the first month of the quarter. All that has a positive impact also this quarter among many, many other things. Obviously, what was more important is the great order performance.

And we don't -- we are not able to operate with a smaller backlog than we used to back 2 years ago before we put in place this tremendous operational improvements in our managing of the orders. And so there, we have bit less visibility potentially than we used to 2 years ago, but it was not very good visibility. Now, it's better in some way..

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

It's Luke in for Ross. So I guess, if -- we're talking a lot about the Intuvo and your new product pipeline.

I guess, can you break out how much of this quarter's growth was due to the new product pipeline? And I guess, more importantly, how has this -- how is your product pipeline that exists now, how does that compare to, say, 3, 4 years ago before Mike took over the helm?.

So I'll take that last one as well. So in terms of the contribution to this quarter's revenue from new products, we don't actually go through any of those internal calculations. But I'd have to say it's been a significant contributor to the growth.

So as you know -- and this is a phenomenon that has been growing for several quarters, right, because for the last 2 years, we bring into the market a number of products. We're talking about the Intuvo right now, but we have the whole infinity two series, a bunch of new spectrometry products. So we've been coming to market.

Jacob's team has been inducing a new genomics offering. So I have to say our business model is based on the ability to get to market new solutions that are differentiated and really do make a difference for our customers.

That's our business model, and I think that's what's been part of the reason combined with our extended channel, which we've been able to grow the way we've been growing. And -- but it may seem like not the most objective view of our performance. In fact, coming in as I put myself in the back a bit, I think our pipelines are much improved.

One -- and if you recall from our earlier discussions, my first [indiscernible] in this role I described for you a massive restructuring of our R&D teams and how we set up our business units and how we put more of our instrumentation, for example, all under Patrick. And we consolidate from 3 different aspect divisions into one.

I think now you're starting to see those -- the impact of those because we now have our monies allocated on the biggest bet, and I think we're able to get to decisions more quickly, and we're able to get to market more quickly.

So I believe that our product lines -- I mean, our pipelines are most robust they've ever been, and I would say to all of you on the call is we're not done yet. So we have a lot of great ideas, very strong team. And I think our -- but our pipeline and portfolio has never been in better shape..

Great. And I guess, turning to the gross margins. They're really strong in the quarter.

Can you just dig in a little bit more there? Like, what was leading that strength in the business [indiscernible] going forward?.

Yes, I'll make some high-level comments, and I think -- then I'll pass it on to Didier. So obviously, topline growth at 9% core growth helps a lot. But we also have a number of initiatives underway in order fulfillment team, our global manufacturing footprint under Henrik.

And we're getting a lot of cost out of our materials, optimizing overhead costs as well as driving down logistics. But anything else you'd add? It's probably a mix impact there, I think, as well..

Nothing to add. Obviously, I chose -- 30 years ago, you started as a -- in the controllership organization, Mike..

Yes, yes..

Nothing to add..

And our next question comes from the line of Derik De Bruin from Bank of America Merrill Lynch..

I guess, I got a couple of short ones since a lot of what I've wanted to know was asked.

Can you just break out the instrument versus consumable organic growth for the quarter?.

Well, I guess, you're probably referring to the analytical side of the house. I think the best way to look at that is just go to the performance of the LSAG and ACG groups. So I believe Patrick was up 6% and -- on a core basis. And Mark and the CrossLab Group was double digit at 10%..

Great. Just on the -- you called out this winning this order in Quest for staining.

Can you give us an idea sort of the magnitude on how that sort of works in the numbers going forward?.

Yes, so we were pretty excited by this, as you imagine. It's a pretty significant win. I think it really is a testament to what we believe is a -- it is an excellent product that the Omnis Autostainer was introduced. It's a real validation of how strong that product offering is.

But Jacob, perhaps, you want to add a few comments in terms of the deal parameters, at least, perhaps, described for Derik how the rollout looks, the multiyear deal..

Yes, Thanks. And as you can imagine, we are quite happy with -- that we won this account. And as you know, Quest is one of the biggest reference laboratories in the U.S., so this is a substantial deal for us.

I cannot go into the actual numbers, but we are looking at a multiple site rollout over the next 6 to 9 months, where we will install on this in all of the Quest sites here in the U.S. And we look at many, many on this and many, many hundred thousands of slides test that will be run on those instruments within a year time frame..

And sort of a follow-up. I remember when you bought Dako back in 2012, the business was sort of underperforming and sort of lagging peers.

Can you sort of talk about where we are sort of with Dako these days? And I guess, how are -- are you sort of going back at the market or the consumable is sort of back where it's going? I mean, is that tracking on where you thought it would be?.

Yes, I mean, so I've been part of that journey for quite a while now, and I'm very pleased where we are today. Omnis is definitely a driver of that. And then, we played instrument to drive consumables. So what is we -- the key indicator for us internally is how our consumables, our test volume, is increasing.

And we can see a very, very strong momentum in the test volume, not only from our PD -L1, but also from our broad portfolio of assays. So I see both strong win over of new accounts and also current accounts driving more and more slides out there. So I will say that we have turned that business around, and there's still a lot we can do.

But I feel like we're now working on an market growth level, and there's more and more to do and much more to come..

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

So just if I could touch briefly on just the GCM. A couple of other questions have already been answered, so maybe if I could ask on the -- overall, in the LC/MS business, seems like that continues to grow. Could you maybe give us a sense of -- if you're taking share with Q-TOF? And appreciate the comments in Q-TOF and triple quads there.

Are you taking share in that market with Q-TOF versus the high-resolution competitors in the market? Or is it more of the biomolecules growth that you continue to see in that market that's propelling the numbers forward?.

First of all, thank you very much for the congratulatory comments, and I think I'll pass it over to Patrick and give you -- share some more insights in terms of what's going on with LC/MS..

Yes. Thank you, Mike. And you're right, Puneet, it's not only the triple quad market that's strong. When you look at the opportunity in Q-TOF, it's playing in the biomolecule market. As Mike said, we just launched a new bio Q-TOF that drives healthy growth on the biopharma. And with that along -- and along that also, we've put the Q-TOF itself.

We also deploy, as you know, the Q-TOF in applied markets like environmental when you do pesticide screening and environmental fluid, et cetera. We have very differentiated solutions from our side, so I think that we have a great opportunity with this platform. We don't disclose market shares and market share gains.

But I would say with what we have launched and also what we're launching at the upcoming ASMS, we are looking very much forward to continue growth in the LC/MS market..

Okay. Got that. Just a brief one, if I could, on the expectations for the pharmDx PD-L1 test that you have in place. There are competitors that have been entering that market with our label expansion.

So has that changed your opportunity overall in that market? What's your thoughts there?.

You want to take that, Jacob?.

Yes, I can take that also, and you're absolutely right that we see competitors entering to the market.

That is not unexpected once you get in a CDx business and when you are departments with a pharma company that you enter and you get a first move advantage, meaning that many accounts have already implemented our test and trained the pathologies in reading out as a slide.

So even as a new competitor coming in there, that is, of course, increased competition. But we believe we are in a very strong position to continue with our leadership position..

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

I wanted to follow up on the back of the Intuvo launch.

Do you think you're seeing more pull through across selling opportunities across the rest of the portfolio? Maybe any intangible signs at CrossLab or elsewhere?.

Yes, absolutely. So we've been calling this the inside to cover the halo effect. So as you may know in this space, gas chromatography is often viewed as a very mature technology. So customers aren't anxious to have a sales rep come out and talk about the gas chromatography.

Different story when you're -- you've got a product like Intuvo, which is it's so different. And customers now recognize that there's really something special here with this offering. So what we're finding is that our account manager was able to go out and get appointments, meet with a customer.

And then that allows us to have a broader discussion around the productivity improvements and enhancements on, for example, our 7890 or we can talk about our enterprise services and consumables. You may have noted -- and I'll ask Mark to chime in on this since he's been the -- probably quiet on call so far on the consumables and services side.

But what we've seen is we get into a different conversation with a customer, and that's why you noticed in my earnings call script, I talked a lot about the broad-based growth in chemical and energy. I think this Intuvo GC has been great to help us get into a different set of conversations with customers.

And, Mark, I don't know if you'd add anything on what you're seeing on the consumables and services side because you had double-digit growth in that space as well..

Well, I have just a couple of things, Mike, and we've talked before about how we've seen the market over the last couple of years.

As customers continued to use their assets, improve the performance of the asset itself, keep their -- obviously, their operations going, and when we see the tailwind, if you will, from now more purchase in the marketplace, it's really more just a surge of new installation that provides some additional revenues in the space.

So overall, though, the differentiation in the market, it comes back to some work we're doing and inside of our chemistries division around new technologies associated with the Intuvo, also advancing some of the chemistries we've done in very traditional space, in GC columns and seeing some nice market gains there.

So all in all, it's just -- it's been proved to be a case where customers continue to buy based on keeping it going, but also on top of that, look towards the additional revenues from the expansion in the energy space..

Yes. Thanks, Mark. And just to kind of close it off, Jack, which I think what we're able to do is actually go out and talk about the whole portfolio with the customer including some of the new capabilities and marketing that's brought on board as well..

That's great. And then I have the follow-up on the margins and DGG. I think it's the best ever on record that we have, at least our model has. Maybe could you just talk about the scalability of the business as you see it now? And was there anything onetime in the quarter? Just you called out the Quest win again. Just any other color..

I mentioned earlier, we're -- the management team is in the conference together taking this call, and there's a big smile on Jacob's face that somebody noticed. And he's well on his task to hitting that -- he's driving for 20% this year. Obviously, the strong revenue performance helped a lot in terms of the operating margin.

But perhaps, you want to build on that?.

Yes, you're absolutely right that we -- the topline drives our bottom line also, so the margin really has driven the 24% margin. Operating margin, we have up 900 basis points, is certainly something I'm very pleased with. What I want to remind also is that if you look into Q1, we come from a lower margin perspective there.

So the 2 quarters, the first half of the year here is really around the 20%, where I believe we have committed to delivering on this business for the full year. So we are still on that track, and that's what we're aiming for..

Maybe I'll just add to that. I mentioned it in my call script, but the early part of this year marked a major milestone for us, which was the integration of the former Dako business into the Agilent infrastructure and systems. And I think that is part of your story.

I mean, that was always part of the plant, but that's also why we think that some of these improvements all being, let's say, a 24% operating margin every quarter. But that's also why I believe some of these improvements are sustainable because we are fundamentally changing the underlying cost structure that support this business..

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

Mike, again, it doesn't look like we're getting together -- Mike, it doesn't look like we're getting together for Analyst Day this spring, so maybe just one on strategy. Wondering if you can offer anything on how interested you are in M&A at this point.

And to the extent that you're looking around at assets, what might you be willing to deploy? And then where might the focus be?.

Yes, I think, first of all, you correctly noted. We're not holding an Analyst Day this year. It's not to say that we won't do it again, but we felt like the first year was important for the management team to come out and tell the new story. I thought it was important a year later to tell you how it's going.

And then a lot of the coaching and obviously [indiscernible] hey, Mike, we really prefer you to have you spend a lot of time just run the business and focus on customers. So that's our plan. But we'll probably back out at some point in time with Analyst Day as we move into '18.

Relative to M&A, I would just leave it as I think what the communication we've had for the prior quarters remain the same, which is we like assets that are in parts of the marketplace, which we see inherently growing faster, whether it be the acquisition we made of Seahorse Bioscience.

And I hope you notice that we called out cell analysis as a driver for growth in our LSAG business. We acquired most recently Multiplicom, which is in a faster-growing molecular diagnostics space. So we like assets that -- where the end markets are growing faster than, perhaps, the corporate average.

We're bringing a new capability to the company, and we love they're accretive short term. And what we realized is that a lot of the deals actually is going to incur, we believe, in the private space. And we have a pretty active funnel. We like the bolt-on acquisitions. We will do every once in a while technology deal, like we did with Lasergen.

We see something that's not out there we don't have. But in general, we want companies with existing customers and revenue that will make a nice run to the company's portfolio..

Got it. Okay. That's helpful. And then, Didier, on the margin outlook. When you guys brought the 22% op margin target in for the year, it's still kind of sell. I think that was a number that you thought you were capable of doing if things went well.

So I guess just given the top line momentum and the progress in terms of the operational stuff, is it right to think about that now? I mean, do you see upside of the 21.5% midpoint for the year just given the trajectory?.

Yes, we had -- I had explained back in November the reasons why we had reduced kind of the guidance from 22% to 21.5%. It was related to 3 factors. But I also pointed out that, internally, we set our performance metric -- internal performance metric be at risk at the same 22% that we had long talked about.

So we do feel that there is a -- we have a shot at it and we were willing to basically put our be at risk there. And since then, we have had some good momentum. And -- but we are absolutely -- it's not yet ready to obviously declare the victory there..

That was interesting, I think. But reflecting back at our first Analyst Day, we put out 3-year goals of 5% core growth and 22% operating profits. We're at the 5% core growth, and we're hoping to find a way to get to 22%. And as Didier mentioned, that's a standard where we're holding ourselves to inside of the company..

And our next question comes from the line of Sara Silverman with Wells Fargo..

I just have a quick one on your free cash flow guidance. It looks like you guys left that unchanged.

And given the guidance raise on revenue's quarter, do you think that may go up? Could you talk about why there's really anything not unchanged? And what's going on with the cash flow?.

Yes, it's a fair question. Obviously, the operating profit is only one of the manufacturers that we look at in the operating cash flow or free cash flow. Similar to, I guess, the answer to the previous question, we do see a path for a higher operating cash flow than what we have guided at, but we're not yet ready to commit to it..

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

This is actually Bill on for Paul. Just one question for you guys. CrossLabs for the past 4 to 8 quarters has been growing high single digit organically.

Can you maybe just talk about how much of that is coming from customers looking to outsource or services for new products? And maybe some -- what are some opportunities to maybe continue to grow that? And then are you seeing some gains in market share as well?.

Yes, so thanks for the question. I'm going to make a few initial reminder comments of how we set up the company, and I'm going to pass it over to Mark for some specifics. But I've been going back to this trip down memory lane a bit, if you will. And 2 years ago, when we set up the company, we formed CrossLab Group.

It really did change our view of the addressable market for the company. We said not only do we want the Agilent install base, but we should view the whole lab ecosystem as the opportunity for Agilent to provide value to our customers.

And we also thought there's some -- starting see some fundamental changes in terms of demand that there'll be some outsourcing from companies such as Big Pharma that were looking for new -- for somebody to take on some of their internal activities. And I think that's happened. It is happening.

So Mark, why don't you kind of build on the story and also talk about how we're doing relative to our wins in the market?.

Thanks, Mike, and thanks for the question. I'll try to be as specific as I can. You asked the question about how much of this is based on outsourcing, it's difficult to say.

But I think if you look at the trends in pharma and even some of the recent studies down there, there's an increasing work to outsourcing as I go for with the area for optimization. I don't think it's accelerated necessarily, but it's still out there.

I would say in our case, we've had a broad focus on the lab operations side and bringing all our components together as complete solutions. And I think that's what's really driving a lot of our growth, is how we're coming together as more of a partner and consulting on how to get the most out of those lab operations.

And competitively, looking at this is at a growing market, are we gaining share? The answer, I think, simply is both. And -- or executing well on the ground in terms of our sales teams across the globe. We're also seeing just our increasing portfolio that goes towards this multivendor area. Hopefully, that helps..

That does. And Mike, maybe just one quick one on capital allocation.

As you think about share buybacks, dividends and with $1.80 net cash, how do you think about what's the optimal strategy for Agilent in terms of leverage or lack thereof?.

Well, we think that we've been describing it as a balanced capital allocation policy, where our primary use of cash is to invest in the business. We talked about M&A a bit already today, but also the investment in our new facility in Colorado.

So we're going to use our cash for -- primarily for investing in the business, but we also want to increasingly grow our cash dividends. So you see every year, we've been bringing up our cash dividend, and we're also using our leverage capability to actually buy back shares.

So the share repurchase program that was announced when I came in as CEO actually was financed through debt. So -- and we like to keep some -- our debt capacity available for M&A as we would see, and we're quite conscious of maintaining the investment grade level rating on our debt.

So I guess, long -- or short of it is no change from the strategy we've been pursuing for the last 2 years..

And our next question comes from line of Catherine Schulte from Robert W. Baird..

Within pharma, you've talked about small molecule customers going to a replacement cycle, any updated thoughts on how much longer that has left? And then can you break out what you saw from small molecule versus biopharma in the quarter?.

Yes. So I think, Patrick, your opinions. I won't go into a baseball analogy, but I think we're -- I won't ask you for the innings. But I think we've always believed we've had at least another 18 months or so of higher demand. By the way, there's always a replacement cycle going on.

We have just been in the accelerated one going on in pharma as it relates to chromatography. We think that we may be seeing the earlier signs of that same thing happening in gas chromatography, but we'll still wait and see on the sidelines for that.

Relative to the -- to mix between small and large molecule, I think it's fair to say that the -- both have been growing quite strongly, but the growth in biopharma is at a higher rate than the small molecule, albeit, a smaller part of our mix. Historically, we've been about 85-15, I guess, between small molecule and large molecule..

About 80-20..

About 80-20, sorry. Yes, 80-20. And we're putting a lot of investment and focus on the biopharma space. So we talked a lot in my call about some of the new solutions, and it's also been a major area of emphasis in terms of investment in our channel as well..

Okay. And then looking at the economic end market.

Can you quantify what growth was across the different geographies and remind us of your exposure by geography in that end market?.

So while Didier is looking for his notes, I'll just say this is the one part of the end market where the pitcher has continued to be quite challenged. The funding level share globally, with perhaps the exception of China, have been fairly weak.

But why don't you provide some of the breakout?.

No, I'll just say it was throughout the world, we saw year-over-year kind of a reduction with the exception mostly of us -- Japan but on the small base, and that surprised us. And there is not much we can wriggle of that because it's on the small base, and parts of -- other parts of Asia Pacific. But the big markets, Americas and Europe, were weak..

Yes.

And my comment's kind of specifically -- specific to the outlook, not the quarter's numbers, right, right?.

Yes..

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

All right. Thank you, Karen. And on behalf of the management team, I'd like to thank everybody for joining us on the call today. If you have any questions, feel free to give us a call on Investor Relations, and thanks again..

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..