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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. This report contains forward-looking statements including, without limitation, statements regarding trends, seasonality and growth in, and drivers of, the markets we sell into, our strategic direction, our future effective tax rate and tax valuation allowance, earnings from our foreign subsidiaries, repatriation of our earnings from foreign jurisdictions and its impact on our tax expense, lease and site services income from Keysight, the impact of foreign currency movements on our performance, our hedging programs, indemnification, new product and service introductions, the ability of our products to meet market needs, adoption of our products, changes to our manufacturing processes, the use of contract manufacturers, out sourcing and third-party package delivery services, source and supply of materials used in our products, the impact of local government regulations on our ability to pay vendors or conduct operations, our liquidity position, our ability to generate cash from operations, growth in our businesses, our investments, including in research and development, the potential impact of adopting new accounting pronouncements, our financial results, our operating margin, our sales, our purchase commitments, our capital expenditures, our contributions to our pension and other defined benefit plans, our strategic initiatives, our cost-control activities and other cost saving initiatives, the integration of our acquisitions and other transactions, impairment of goodwill and other intangible assets, write down of investment values or loans and convertible notes, our stock repurchase program, our declared dividends, and the existence of economic instability, that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to various factors, including those discussed in Part I Item 1A and elsewhere in this Form 10-K.
Overview and Executive Summary
Agilent Technologies Inc. ("we", "Agilent" or the "company"), incorporated in Delaware in May 1999, is a global leader in life sciences, diagnostics and applied chemical markets, providing application focused solutions that includes instruments, software, services and consumables for the entire laboratory workflow.
On January 20, 2017, we completed the acquisition of 100 percent of the stock of Multiplicom NV (“Multiplicom”), a leading European diagnostics company with state-of-the-art genetic testing technology and products, for approximately $72 million in cash. Multiplicom, headquartered in Belgium, develops, manufactures and commercializes molecular diagnostic assays, provided as kits, which enable personalized medicine. The financial results of Multiplicom have been included within Agilent's from the date of the transaction.
On July 7, 2017, we completed the acquisition of Cobalt Light Systems (“Cobalt”) for approximately $53 million in cash. Cobalt, based in Oxfordshire, U.K., is a provider of differentiated Raman spectroscopic instruments for the pharmaceutical industry, applied markets and public safety. Cobalt's suite of benchtop and handheld/portable Raman spectroscopic instruments are based on proprietary technologies that enable through-barrier identification of chemicals and materials. The financial results of Cobalt have been included within Agilent's from the date of the transaction.
In fiscal year 2016, we completed the acquisition of Seahorse Bioscience ("Seahorse") for $242 million and iLab Solutions LLC ("iLab") for $26 million. The financial results of Seahorse and iLab have been included within Agilent's from the date of the transaction. On March 2, 2016, we also made a preferred stock investment in Lasergen for $80 million. Lasergen is a Variable Interest Entity ("VIE"), however, we do not consolidate the entity in our financial statements because we do not have the power to direct the activities of the VIE that most significantly impact the VIE's economic performance. Because of the nature of the preferred stock of Lasergen that we own, we account for this investment under the cost method.
Agilent's net revenue of $4,472 million in 2017 increased 6 percent when compared to 2016. Foreign currency movements for 2017 had an unfavorable impact of approximately 1 percentage point compared to 2016. Agilent's net revenue of $4,202 million increased 4 percent in 2016 when compared to 2015.
Revenue in the life sciences and applied markets business increased 5 percent in 2017 when compared to 2016. Foreign currency movements had an unfavorable impact of less than 1 percentage point in 2017 when compared to 2016. For the year ended October 31, 2017, our performance within the life sciences markets was led by solid growth in the biotechnology and pharmaceutical markets. Within the applied markets, there was strong growth in the chemical and energy, food and environmental markets. Revenue in the life sciences and applied markets business increased 1 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. For the year ended October 31, 2016 and excluding the impact of foreign currency movements, acquisitions and the NMR business our performance within the life sciences market continued to show strong revenue growth from the pharmaceutical and biotechnology markets. Within the applied markets, and excluding the impact of foreign currency movements and the NMR business for 2016
when compared to 2015, there was strong growth in both the environmental and food markets, but revenue from sales to other applied markets was weak with a decline in revenue from sales to the chemical and energy markets.
Revenue in the diagnostics and genomics business increased 9 percent in 2017 when compared to 2016. Foreign currency movements had no overall currency impact on revenue growth in 2017 when compared to 2016. For the year ended October 31, 2017, our performance within the clinical and diagnostics market continued to improve with strong revenue growth from our companion diagnostics and pathology businesses. Revenue in the diagnostics and genomics business increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 1 percentage point in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, growth in revenue from sales to the diagnostics and clinical research markets continued to be strong, led by our companion diagnostics and genomics businesses in the year ended October 31, 2016 when compared to the prior year.
Revenue generated by Agilent CrossLab increased 8 percent in 2017 when compared to 2016. Foreign currency movements had an unfavorable impact of less than 1 percentage point in 2017 when compared to 2016. Revenue grew across all key end markets led by strong growth in the biotechnology and pharmaceutical, chemical and energy and food markets. Revenue generated by Agilent CrossLab increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, there was growth in sales to all key markets. The pharmaceutical and biotechnology markets led all the markets in revenue and revenue growth along with very strong revenue growth from the food markets. In addition, we saw moderate growth from the environmental market and modest revenue growth from the chemical and energy markets.
Net income from continuing operations was $684 million in 2017 compared to net income from continuing operations of $462 million and $438 million in 2016 and 2015, respectively. As of October 31, 2017 and 2016, we had cash and cash equivalents balances of $2,678 million and $2,289 million, respectively.
On November 22, 2013, we announced that our board of directors had authorized a share repurchase program. The program was designed to reduce or eliminate dilution resulting from issuance of stock under the company's employee equity incentive programs to target maintaining a weighted average share count of approximately 335 million diluted shares. For the year ended October 31, 2015 we repurchased 6 million shares for $267 million. For the year ended October 31, 2016 we repurchased approximately 2.4 million shares for $98 million which completed the purchases under this authorization.
On May 28, 2015 we announced that our board of directors had approved a new share repurchase program (the "2015 repurchase program"). The 2015 share repurchase program authorizes the purchase of up to $1.14 billion of our common stock at the company's discretion through and including November 1, 2018. The 2015 repurchase program does not require the company to acquire a specific number of shares and may be suspended or discontinued at any time; however, we plan to repurchase a minimum of 674,000 shares per quarter in fiscal year 2018. Any additional repurchases may be impacted by our share price as well as other market conditions. During the year ended October 31, 2016, upon the completion of our previous repurchase program, we repurchased approximately 8.3 million shares for $336 million under this authorization. During the year ended October 31, 2017 we repurchased approximately 4.1 million shares for $194 million under this authorization. As of October 31, 2017, we had remaining authorization to repurchase up to $610 million of our common stock under this program.
During fiscal year 2017, we retired 294.2 million treasury shares at an aggregate cost of $10.7 billion, the amount of which represents all of our previously repurchased shares over the past 12 years including 2017 repurchases. Also the retirement resulted in a decrease of $6.7 billion to retained earnings and a decrease of $4 billion to additional paid-in-capital.
For the years ended October 31, 2017, 2016 and 2015, cash dividends of $170 million, $150 million and $133 million were paid on the company's outstanding common stock, respectively. On November 15, 2017, we declared a quarterly dividend of $0.149 per share of common stock, or approximately $48 million which will be paid on January 24, 2018 to shareholders of record as of the close of business on January 2, 2018. The timing and amounts of any future dividends are subject to determination and approval by our board of directors.
Looking forward, we expect to continue to focus on the growth of operating margin in our businesses by exploring new ways to simplify our operations, differentiate product solutions and improve our customers' experience. In addition, we remain focused on returning a significant proportion of our cash flow to shareholders through our dividend and share repurchase programs. We are entering fiscal year 2018 with good momentum. However, considering the macroeconomic and political uncertainties, and corresponding poor visibility on our end-markets for most of fiscal year 2018, we remain cautious on our revenue projections for most of fiscal year 2018. Therefore, we expect our revenue growth in the pharmaceutical and biotechnology market to moderate slightly downward in fiscal year 2018. Although we experienced strong revenue growth within the chemical and energy market in fiscal year 2017, we are expecting lower revenue growth in fiscal year 2018. Within the clinical and diagnostics market, we
remain optimistic about our revenue growth opportunities in these markets and continue to invest in expanding and improving our solutions portfolio. The unfavorable effects of changes in foreign currency exchange rates has decreased revenue by approximately 1 percentage point for the year ended October 31, 2017. Costs and expenses, incurred in local currency, were subject to the favorable effects due to changes in foreign currency exchange rates reducing our overall net exposure. The impact of foreign currency exchange rates movements can be positive or negative in any period and is calculated by applying the prior period foreign currency exchange rates to the current year period.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management's best knowledge of current events and actions that may impact the company in the future, actual results may be different from the estimates. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, inventory valuation, share-based compensation, retirement and post-retirement plan assumptions, valuation of goodwill and purchased intangible assets and accounting for income taxes.
Revenue Recognition. We enter into agreements to sell products (hardware or software), services, and other arrangements (multiple element arrangements) that include combinations of products and services. Revenue from product sales, net of trade discounts and allowances, is recognized provided that persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. Delivery is considered to have occurred when title and risk of loss have transferred to the customer. Revenue is reduced for estimated product returns, when appropriate. For sales that include customer-specified acceptance criteria, revenue is recognized after the acceptance criteria have been met. For products that include installation, if the installation meets the criteria to be considered a separate element, product revenue is recognized upon delivery, and recognition of installation revenue occurs when the installation is complete. Otherwise, neither the product nor the installation revenue is recognized until the installation is complete. Revenue from services is deferred and recognized over the contractual period or as services are rendered and accepted by the customer. We allocate revenue to each element in our multiple-element arrangements based upon their relative selling prices. We determine the selling price for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on our vendor specific objective evidence (VSOE) if available, third-party evidence (TPE) if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. Revenue from the sale of software products that are not required to deliver the tangible product's essential functionality are accounted for under software revenue recognition rules. Revenue allocated to each element is then recognized when the basic revenue recognition criteria for that element have been met. The amount of product revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements.
The aforementioned factors may result in a different allocation of revenue to the deliverables in multiple element arrangements, which may change the pattern and timing of revenue recognition for these elements but will not change the total revenue recognized for the arrangement.
Inventory Valuation. We assess the valuation of our inventory on a periodic basis and make adjustments to the value for estimated excess and obsolete inventory based upon estimates about future demand and actual usage. Such estimates are difficult to make under most economic conditions. The excess balance determined by this analysis becomes the basis for our excess inventory charge. Our excess inventory review process includes analysis of sales forecasts, managing product rollovers and working with manufacturing to maximize recovery of excess inventory. If actual market conditions are less favorable than those projected by management, additional write-downs may be required. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold to customers, resulting in lower cost of sales and higher income from operations than expected in that period.
Share-Based Compensation. We account for share-based awards in accordance with the authoritative guidance. Under the authoritative guidance, share-based compensation expense is primarily based on estimated grant date fair value and is recognized on a straight line basis. The fair value of share-based awards for employee stock option awards was estimated using the Black-Scholes option pricing model. Stock options were granted in years prior to fiscal year 2016. Shares granted under the Long-Term Performance Program based on Total Shareholders Return ("LTPP-TSR") were valued using the Monte Carlo simulation model. The estimated fair value of restricted stock unit awards, LTPP based on Operating Margin (“LTPP-OM”) and LTPP based on
Earnings per share (“LTPP-EPS”) is determined based on the market price of Agilent's common stock on the date of grant adjusted for expected dividend yield. The compensation cost for LTPP (OM) and LTPP (EPS) reflects the cost of awards that are probable to vest at the end of the performance period. In the case of LTPP-OM, the performance targets for all the three years of performance period is set at the time of grant. The performance targets for LTPP-EPS grants for year 2 and year 3 of the performance period will be set in the first quarter of year 2 and year 3, respectively. The probable shares to vest are estimated based on the forecasted OM and EPS at the time of the grant and updated every quarter with latest forecast and actual information. The Employee Stock Purchase Plan ("ESPP") allows eligible employees to purchase shares of our common stock at 85 percent of the fair market value at the purchase date. All awards granted in 2017 and 2016 to our senior management employees have a one year post-vest holding restriction. The estimated discount associated with post-vest holding restrictions is calculated using the Finnerty model.
Both the Black-Scholes and Monte Carlo simulation fair value models require the use of highly subjective and complex assumptions, including the option's expected life and the price volatility of the underlying stock. For the stock option grants in 2015 and LTPP (TSR) grants in 2015 and 2016, we used the 3-year average historical stock price volatility of a group of our peer companies. We believed our historical volatility prior to the separation of Keysight in 2015 was no longer relevant to use. For the 2017 LTPP (TSR) grants and calculation of the post-vest discount using the Finnerty model, we used our own post-separation historical stock price volatility. See Note 4, "Share-based Compensation," to the consolidated financial statements for more information.
The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. Although we believe the assumptions and estimates we have made are reasonable and appropriate, changes in assumptions could materially impact our reported financial results.
Retirement and Post-Retirement Benefit Plan Assumptions. Retirement and post-retirement benefit plan costs are a significant cost of doing business. They represent obligations that will ultimately be settled sometime in the future and therefore are subject to estimation. Pension accounting is intended to reflect the recognition of future benefit costs over the employees' average expected future service to Agilent based on the terms of the plans and investment and funding decisions. To estimate the impact of these future payments and our decisions concerning funding of these obligations, we are required to make assumptions using actuarial concepts within the framework of accounting principles generally accepted in the U.S. Two critical assumptions are the discount rate and the expected long-term return on plan assets. Other important assumptions include, expected future salary increases, expected future increases to benefit payments, expected retirement dates, employee turnover, retiree mortality rates, and portfolio composition. We evaluate these assumptions at least annually.
The discount rate is used to determine the present value of future benefit payments at the measurement date - October 31 for both U.S. and non-U.S. plans. For 2017 and 2016, the U.S. discount rates were based on the results of matching expected plan benefit payments with cash flows from a hypothetically constructed bond portfolio. In 2017, discount rates for the U.S. plans were the same as the previous year. For 2017 and 2016, the discount rate for non-U.S. plans was generally based on published rates for high quality corporate bonds and in 2017, were approximately the same as the previous year. If we changed our discount rate by 1 percent, the impact would be less than $1 million on U.S. pension expense and $16 million on non-U.S. pension expense. Lower discount rates increase present values of the pension benefit obligation and subsequent year pension expense; higher discount rates decrease present values of the pension benefit obligation and subsequent year pension expense.
The company uses alternate methods of amortization as allowed by the authoritative guidance which amortizes the actuarial gains and losses on a consistent basis for the years presented. For U.S. Plans, gains and losses are amortized over the average future lifetime of participants using the corridor method. For most Non-U.S. Plans and U.S. Post-Retirement Benefit Plans, gains and losses are amortized using a separate layer for each year's gains and losses. The expected long-term return on plan assets is estimated using current and expected asset allocations as well as historical and expected returns. Plan assets are valued at fair value. If we changed our estimated return on assets by 1 percent, the impact would be $4 million on U.S. pension expense and $9 million on non-U.S. pension expense. For 2017, actual return on assets was above expectations which, along with contributions during the year, decreased next year’s pension cost as well as resulting in an improvement of the funded status at year end. The net periodic pension and post-retirement benefit costs recorded were a $15 million benefit in 2017, $3 million expense in 2016 and $26 million expense in 2015. The year ended October 31, 2017 and 2016, included a $32 million and $16 million, respectively, gain on curtailment and settlement.
Goodwill and Purchased Intangible Assets. Under the authoritative guidance, we have the option to perform a qualitative assessment to determine whether further impairment testing is necessary. The accounting standard gives an entity the option to first assess qualitative factors to determine whether performing the two-step test is necessary. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not (i.e. greater than 50% chance) that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test will be required. Otherwise, no further testing will be required.
The guidance includes examples of events and circumstances that might indicate that a reporting unit's fair value is less than its carrying amount. These include macro-economic conditions such as deterioration in the entity's operating environment or industry or market considerations; entity-specific events such as increasing costs, declining financial performance, or loss of key personnel; or other events such as an expectation that a reporting unit will be sold or a sustained decrease in the stock price on either an absolute basis or relative to peers.
If it is determined, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the provisions of authoritative guidance require that we perform a two-step impairment test on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. The second step (if necessary) measures the amount of impairment by applying fair-value-based tests to the individual assets and liabilities within each reporting unit. As defined in the authoritative guidance, a reporting unit is an operating segment, or one level below an operating segment. We aggregate components of an operating segment that have similar economic characteristics into our reporting units.
In fiscal year 2017, we assessed goodwill impairment for our three reporting units which consisted of three segments: life sciences and applied markets, diagnostics and genomics and Agilent CrossLab. We performed a qualitative test for goodwill impairment of the three reporting units, as of September 30, 2017. Based on the results of our qualitative testing, we believe that it is more-likely-than-not that the fair value of these reporting units are greater than their respective carrying values. Each quarter we review the events and circumstances to determine if goodwill impairment is indicated. There was no impairment of goodwill during the years ended October 31, 2017, 2016 and 2015.
Purchased intangible assets consist primarily of acquired developed technologies, proprietary know-how, trademarks, and customer relationships and are amortized using the best estimate of the asset's useful life that reflect the pattern in which the economic benefits are consumed or used up or a straight-line method ranging from 6 months to 15 years. In-process research and development ("IPR&D") is initially capitalized at fair value as an intangible asset with an indefinite life and assessed for impairment thereafter. When the IPR&D project is complete, it is reclassified as an amortizable purchased intangible asset and is amortized over its estimated useful life. If an IPR&D project is abandoned, we will record a charge for the value of the related intangible asset to our consolidated statement of operations in the period it is abandoned.
Our indefinite-lived intangible assets are IPR&D intangible assets. The accounting guidance allows a qualitative approach for testing indefinite-lived intangible assets for impairment, similar to the issued impairment testing guidance for goodwill and allows the option to first assess qualitative factors (events and circumstances) that could have affected the significant inputs used in determining the fair value of the indefinite-lived intangible asset to determine whether it is more-likely-than-not (i.e. greater than 50% chance) that the indefinite-lived intangible asset is impaired. An organization may choose to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to calculating its fair value. We performed a qualitative test for impairment of indefinite-lived intangible assets as of September 30, 2017. Based on the results of our qualitative testing, we believe that it is more-likely-than-not that the fair value of these indefinite-lived intangible assets is greater than their respective carrying values. Each quarter we review the events and circumstances to determine if impairment of indefinite-lived intangible asset is indicated. During the year ended October 31, 2017, there were no impairments of indefinite-lived intangible assets. Based on triggering events in the years ended October 31, 2016 and 2015, we recorded an impairment of $4 million and $3 million, respectively due to the cancellation of certain IPR&D projects.
Accounting for Income Taxes. We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits and deductions, and in the calculation of certain tax assets and liabilities which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.
Significant management judgment is also required in determining whether deferred tax assets will be realized in full or in part. When it is more-likely-than-not that all or some portion of specific deferred tax assets such as net operating losses or foreign tax credit carryforwards will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that cannot be realized. We consider all available positive and negative evidence on a jurisdiction-by-jurisdiction basis when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of losses in recent years and our forecast of future taxable income. At October 31, 2017, we continue to recognize a valuation allowance for certain U.S. and U.S state and foreign deferred tax assets. We intend to maintain a valuation allowance in these jurisdictions until sufficient positive evidence exists to support its reversal.
We have not provided for all U.S. federal income and foreign withholding taxes on the undistributed earnings of some of our foreign subsidiaries because we intend to reinvest such earnings indefinitely. Should we decide to remit this income to the
U.S. in a future period of if there is a U.S. tax law change with respect to taxation of accumulated foreign earnings, our provision for income taxes may increase materially in that period.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax law and regulations in a multitude of jurisdictions. Although the guidance on the accounting for uncertainty in income taxes prescribes the use of a recognition and measurement model, the determination of whether an uncertain tax position has met those thresholds will continue to require significant judgment by management. In accordance with the guidance on the accounting for uncertainty in income taxes, for all U.S. and other tax jurisdictions, we recognize potential liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes and interest will be due. The ultimate resolution of tax uncertainties may differ from what is currently estimated, which could result in a material impact on income tax expense. If our estimate of income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. We include interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of operations.
As a part of our accounting for business combinations, intangible assets are recognized at fair values and goodwill is measured as the excess of consideration transferred over the net estimated fair values of assets acquired. Impairment charges associated with goodwill are generally not tax deductible and will result in an increased effective income tax rate in the period that any impairment is recorded. Amortization expenses associated with acquired intangible assets are generally not tax deductible and therefore deferred tax liabilities have been recorded for non-deductible amortization expenses as a part of the accounting for business combinations.
The U.S. Congress passed tax legislation on December 20, 2017 which broadly reforms the corporate tax system but the legislation must be signed by the U.S. President before it is considered enacted. The tax reform could have a significant impact on our effective tax rate, cash tax expenses and/or net deferred tax assets. The tax reform law would reduce the U.S. corporate tax rate, eliminates or limits deduction of several expenses which were previously deductible, imposes a mandatory deemed repatriation tax on undistributed historic earnings of foreign subsidiaries, requires a minimum tax on earnings generated by foreign subsidiaries and permits a tax-free repatriation of foreign earnings through a dividends received deduction. We are evaluating the overall impact of the tax reform on our effective tax rate and balance sheet but we are unable to quantify the impact at this time.
Adoption of New Pronouncements
See Note 2, "New Accounting Pronouncements," to the consolidated financial statements for a description of new accounting pronouncements.
Foreign Currency
Our revenues, costs and expenses, and monetary assets and liabilities are exposed to changes in foreign currency exchange rates as a result of our global operating and financing activities. The unfavorable effects of changes in foreign currency exchange rates has decreased revenue by approximately 1 percentage point for the year ended October 31, 2017 and 2 percentage points for the year ended October 31, 2016. Costs and expenses, incurred in local currency, were subject to the favorable effects due to changes in foreign currency exchange rates for the years ended October 31, 2017 and 2016, reducing our overall net exposure. The impact of foreign currency exchange rates movements can be positive or negative in any period and is calculated by applying the prior period foreign currency exchange rates to the current year period. We hedge revenues, expenses and balance sheet exposures that are not denominated in the functional currencies of our subsidiaries on a short term and anticipated basis. We do experience some fluctuations within individual lines of the consolidated statement of operations and balance sheet because our hedging program is not designed to offset the currency movements in each category of revenues, expenses, monetary assets and liabilities. Our hedging program is designed to hedge currency movements on a relatively short-term basis (up to a rolling twelve-month period). Therefore, we are exposed to currency fluctuations over the longer term. To the extent that we are required to pay for all, or portions, of an acquisition price in foreign currencies, we may enter into foreign exchange contracts to reduce the risk that currency movements will impact the U.S. dollar cost of the transaction.
Results from Operations
Net Revenue
| Years Ended October 31, | 2017 over 2016 % Change | 2016 over 2015 % Change | |||||||||||||
| 2017 | 2016 | 2015 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue: | |||||||||||||||
| Products | $ | 3,410 | $ | 3,227 | $ | 3,146 | 6% | 3% | |||||||
| Services and other | $ | 1,062 | $ | 975 | $ | 892 | 9% | 9% | |||||||
| Total net revenue | $ | 4,472 | $ | 4,202 | $ | 4,038 | 6% | 4% |
| Years Ended October 31, | 2017 over 2016 ppts Change | 2016 over 2015 ppts Change | ||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| % of total net revenue: | ||||||||||||
| Products | 76 | % | 77 | % | 78 | % | (1) ppt | (1) ppt | ||||
| Services and other | 24 | % | 23 | % | 22 | % | 1 ppt | 1 ppt | ||||
| Total | 100 | % | 100 | % | 100 | % |
Agilent's net revenue of $4,472 million in October 31, 2017 increased 6 percent when compared to 2016. Foreign currency movements for 2017 had an unfavorable impact of approximately 1 percentage point compared to 2016. Agilent's net revenue of $4,202 million increased 4 percent in 2016 when compared to 2015.
Product revenue includes revenue generated from the sales of our analytical instrumentation, software and consumables. Services and other revenue includes revenue generated from servicing our installed base of products, warranty extensions and consulting including companion diagnostics. Services and other revenue increased 9 percent in 2017 as compared to 2016. The service and other revenue growth is impacted by a portion of the revenue being driven by the current and previously installed product base. Service and other revenue increased due to continued strong companion diagnostics revenue and increases across nearly all service types. Services and other revenue increased 9 percent in 2016 as compared to 2015. Service and other revenue increased due to increased service contract repairs, compliance services and preventative maintenance, and strong companion diagnostics revenue.
Net Revenue By Segment
| Years Ended October 31, | 2017 over 2016 % Change | 2016 over 2015 % Change | |||||||||||||
| 2017 | 2016 | 2015 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue by segment: | |||||||||||||||
| Life sciences and applied markets | $ | 2,169 | $ | 2,073 | $ | 2,046 | 5% | 1% | |||||||
| Diagnostics and genomics | $ | 772 | $ | 709 | $ | 662 | 9% | 7% | |||||||
| Agilent CrossLab | $ | 1,531 | $ | 1,420 | $ | 1,330 | 8% | 7% | |||||||
| Total net revenue | $ | 4,472 | $ | 4,202 | $ | 4,038 | 6% | 4% |
Revenue in the life sciences and applied markets business increased 5 percent in 2017 when compared to 2016. Foreign currency movements had an unfavorable impact of less than 1 percentage point in 2017 when compared to 2016. For the year ended October 31, 2017, our performance within the life sciences markets was led by solid growth in the biotechnology and pharmaceutical markets. Within the applied markets, there was strong growth in the chemical and energy, food and environmental markets. Revenue in the life sciences and applied markets business increased 1 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. For the year ended October 31, 2016 and excluding the impact of foreign currency movements, acquisitions and the NMR business, our performance within the life sciences market continued to show strong revenue growth from the pharmaceutical and biotechnology markets. Within the applied markets, and excluding the impact of foreign currency movements and the NMR business for 2016 when compared to 2015, there was strong growth in both the environmental and food markets, but revenue from sales to other applied markets was weak with a decline in revenue from sales to the chemical and energy markets.
Revenue in the diagnostics and genomics business increased 9 percent in 2017 when compared to 2016. Foreign currency movements had no overall currency impact on revenue growth in 2017 when compared to 2016. For the year ended October 31, 2017, our performance within the clinical and diagnostics market continued to improve with strong revenue growth from our companion diagnostics and pathology businesses. Revenue in the diagnostics and genomics business increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 1 percentage point in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, growth in revenue from sales to the diagnostics and clinical research markets continued to be strong, led by our companion diagnostics and genomics businesses in the year ended October 31, 2016 when compared to the prior year.
Revenue generated by Agilent CrossLab increased 8 percent in 2017 when compared to 2016. Foreign currency movements had an unfavorable impact of less than 1 percentage point in 2017 when compared to 2016. Revenue grew across all key end markets led by strong growth in the biotechnology and pharmaceutical, chemical and energy and food markets. Revenue generated by Agilent CrossLab increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, there was growth in sales to all key markets. The pharmaceutical and biotechnology markets led all the markets in revenue and revenue growth along with very strong revenue growth from the food markets. In addition, we saw moderate growth from the environmental market and modest revenue growth from the chemical and energy markets.
Costs and Expenses
| Years Ended October 31, | 2017 over 2016 Change | 2016 over 2015 Change | ||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Gross margin on products | 56.9 | % | 54.6 | % | 52.5 | % | 2 ppts | 2 ppts | ||||
| Gross margin on services and other | 44.1 | % | 44.5 | % | 43.8 | % | — | 1 ppt | ||||
| Total gross margin | 53.9 | % | 52.3 | % | 50.5 | % | 2 ppts | 2 ppts | ||||
| Operating margin | 18.8 | % | 14.6 | % | 12.9 | % | 4 ppts | 2 ppts |
| (in millions) | |||||||||||||||
| Research and development | $ | 339 | $ | 329 | $ | 330 | 3% | — | |||||||
| Selling, general and administrative | $ | 1,229 | $ | 1,253 | $ | 1,189 | (2)% | 5% |
Total gross margin for the year ended October 31, 2017 increased 2 percentage points when compared to last year. Increases in total gross margins for the year ended October 31, 2017 reflects higher sales volume, results from margin improvement initiatives, lower amortization expense of intangible assets and the impact of an employee pension settlement gain partially offset by higher wages and variable pay. Total gross margin for the year ended October 31, 2016 increased 2 percentage points when compared to last year. Increases in total gross margins for the year ended October 31, 2016 were as a result of the exit of the NMR business, several margin improvement initiatives, lower logistics costs, lower costs to address the now lifted FDA warning letter offset by increased wages and variable pay.
Total operating margin increased 4 percentage points for the year ended October 31, 2017, when compared to last year. Operating margins increased due to improvements in gross margins, the impact of lower amortization expense of intangible assets, lower transformation initiatives costs, lower acquisition and integration costs and the impact of an employee pension settlement gain when compared to last year. Total operating margin increased 2 percentage points for the year ended October 31, 2016, when compared to last year. Operating margins increased due to improvements in gross margin and the impact of an employee pension curtailment gain offset by the increased acquisition and integrations costs, the impairment charge for investment-related loans and increased wages and variable pay.
Gross inventory charges were $24 million in 2017, $20 million in 2016 and $30 million in 2015. Sales of previously written down inventory were $9 million in 2017, $9 million in 2016 and $13 million in 2015.
Our research and development efforts focus on potential new products and product improvements covering a wide variety of technologies, none of which is individually significant to our operations. Our research seeks to improve on various technical competencies in software, systems and solutions, life sciences and diagnostics. In each of these research fields, we conduct research that is focused on specific product development for release in the short-term as well as other research that is intended to be the foundation for future products over a longer time-horizon. Most of our product development research is designed to improve products already in production, focus on major new product releases, and develop new product segments for the future. Due to
the breadth of research and development projects across all of our businesses, there are a number of drivers of this expense. We remain committed to invest significantly in research and development and have focused our development efforts on key strategic opportunities to align our business with available markets and position ourselves to capture market share.
Research and development expenses increased 3 percent for the year ended October 31, 2017 when compared with last year. Research and development expenditures increased due to increased spending on new products related to all of our businesses, additional expenses related to increased headcount from acquisitions, and higher wages and variable pay. Research and development expenses was relatively flat for the year ended October 31, 2016 when compared with last year. Research and development expenditures increased by a $4 million in-process research and development (IPR&D) impairment charge mostly offset by the impact of an employee pension curtailment gain.
Selling, general and administrative expenses decreased 2 percent in 2017 compared to 2016. Selling, general and administrative expenses decreased due to lower amortization expense from intangible assets, lower transformational initiatives, lower acquisition and integration costs, the impact of an employee pension settlement gain and reduced costs due to business improvement initiatives partially offset by higher wages and variable pay and additional selling, general and administrative expenses associated with our recent acquisitions. Selling, general and administrative expenses increased 5 percent in 2016 compared to 2015. Selling, general and administrative expenses increased due to acquisition and integration costs related to recently acquired businesses, higher wages and variable pay and an impairment charge related to equity method investment loans offset by the impact of an employee pension curtailment gain.
Interest expense for the years ended October 31, 2017, 2016 and 2015 was $79 million, $72 million and $66 million, respectively, and relates to the interest charged on our senior notes and the amortization of the deferred loss recorded upon termination of the forward starting interest rate swap contracts offset by the amortization of deferred gains recorded upon termination of interest rate swap contracts.
At October 31, 2017, our headcount was approximately 13,500 compared to 12,500 in 2016.
Other income (expense), net
For the years ended October 31, 2017, 2016 and 2015, other income (expense), net includes income of $12 million, $12 million and $25 million, respectively, related to the provision of certain IT and site service costs to, and lease income from, Keysight. The costs associated with these services are reported within income from operations. Agilent expects to receive lease income and site service income from Keysight over the next 2-3 years of approximately $12 million per year. For the year ended October 31, 2016, other income (expense), net also includes an $18 million expense related to the impairment of an investment.
Income Taxes
| Years Ended October 31, | |||||||||||
| 2017 | 2016 | 2015 | |||||||||
| (in millions) | |||||||||||
| Provision for income taxes | $ | 119 | $ | 82 | $ | 42 |
For 2017, the company's income tax expense was $119 million with an effective tax rate of 14.8 percent. Our effective tax rate is impacted by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. During the year, the company determined a portion of current year foreign earnings from its low tax jurisdictions would not be considered as indefinitely reinvested. As such, a deferred tax liability for that portion of unremitted foreign earnings was accrued causing an increase in the annual tax expense. Our annual effective tax rate also included tax benefits due to the settlement of an audit in Germany for the years 2005 through 2008 and the lapse of U.S. statute of limitation for the fiscal years 2012 and 2013. This benefit was offset by a deferred tax liability required for the tax expected upon repatriation of related unremitted foreign earnings that were not asserted as indefinitely invested outside the U.S.
For 2016, the company's income tax expense was $82 million with an effective tax rate of 15.1 percent. The income tax provision from continuing operations for the year ended October 31, 2016 included net discrete tax expense of $17 million primarily due to tax expense related to the establishment of a valuation allowance on an equity method investment impairment that would generate a capital loss when realized.
For 2015, the company’s income tax expense from continuing operations was $42 million with an effective tax rate of 8.7 percent. The income tax expense from continuing operations for the year ended October 31, 2015 included a net discrete tax
benefit of $(55) million primarily due to the settlement of an Internal Revenue Service (“IRS) audit in the U.S. and the recognition of tax expense related to the repatriation of dividends.
Agilent enjoys tax holidays in several different jurisdictions, most significantly in Singapore. The tax holidays provide lower rates of taxation on certain classes of income and require various thresholds of investments and employment or specific types of income in those jurisdictions. The tax holidays are due for renewal between 2018 and 2023. As a result of the incentives, the impact of the tax holidays decreased income taxes by $93 million, $86 million, and $65 million in 2017, 2016, and 2015, respectively. The benefit of the tax holidays on net income per share (diluted) was approximately $0.29, $0.26, and $0.19 in 2017, 2016 and 2015, respectively.
In accordance with the guidance on the accounting for uncertainty in income taxes, for all U.S. and other tax jurisdictions, we recognize potential liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes and interest will be due. If our estimate of income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. We include interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of operations.
In the U.S., tax years remain open back to the year 2014 for federal income tax purposes and the year 2000 for significant states. There were no substantial changes to the status of these open tax years during 2017. The U.S. statute of limitation for audit of tax returns for the fiscal years 2012 and 2013 expired in July, 2017. The statute expiration resulted in the recognition, within the continuing operations, of previously unrecognized tax benefits of $40 million. This discrete tax benefit was offset by a deferred tax liability required for the tax expected upon repatriation of related unremitted foreign earnings that were not asserted as indefinitely invested outside the U.S.
On September 22, 2015, we reached an agreement with the Internal Revenue Service ("IRS") for the tax years 2008 through 2011. The settlement resulted in the recognition, within the continuing operations, of previously unrecognized tax benefits of $119 million, offset by a tax liability on foreign distributions of approximately $99 million principally related to the repatriation of foreign earnings.
In other major jurisdictions where the company conducts business, the tax years generally remain open back to the year 2001. During the first quarter of fiscal year 2017, the company settled its ongoing tax audit in Italy for the years 2011 to 2013 resulting in a net tax expense of $7 million. The settlement resulted in the recognition of previously unrecognized tax benefits of approximately $14 million. During the third quarter of fiscal year 2017, the company settled its ongoing tax audit in Germany for the years 2005 to 2008, which resulted in the recognition of previously unrecognized tax benefits of approximately $51 million.
With these jurisdictions and the U.S., it is reasonably possible that there could be significant changes to our unrecognized tax benefits in the next twelve months due to either the expiration of a statute of limitation or a tax audit settlement which will be partially offset by an anticipated tax liability related to unremitted foreign earnings, where applicable. Given the number of years and numerous matters that remain subject to examination in various tax jurisdictions, management is unable to estimate the range of possible changes to the balance of our unrecognized tax benefits.
On July 27, 2015, the U.S. Tax Court issued an opinion in Altera Corp. v. Commissioner related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. A final decision was entered by the U.S. Tax Court on December 1, 2015. At this time, the U.S. Department of the Treasury has not withdrawn the requirement from its regulations to include stock-based compensation. The IRS appealed the decision and filed its arguments opposing the Tax Court decision in June 2016. The case is currently in the appeals process in the Ninth Circuit. Due to the uncertainty surrounding the Court’s decision, we concluded that no adjustment to our consolidated financial statements is appropriate at this time.
Segment Overview
Through October 31, 2017, we have three business segments comprised of the life sciences and applied markets business, the diagnostics and genomics business and the Agilent CrossLab business.
Life Sciences and Applied Markets
Our life sciences and applied markets business provides application-focused solutions that include instruments and software that enable customers to identify, quantify and analyze the physical and biological properties of substances and products, as well as enable customers in the clinical and life sciences research areas to interrogate samples at the molecular and cellular level. Key
product categories include: liquid chromatography ("LC") systems and components; liquid chromatography mass spectrometry ("LCMS") systems; gas chromatography ("GC") systems and components; gas chromatography mass spectrometry ("GCMS") systems; inductively coupled plasma mass spectrometry ("ICP-MS") instruments; atomic absorption ("AA") instruments; microwave plasma-atomic emission spectrometry (“MP-AES”) instruments; inductively coupled plasma optical emission spectrometry ("ICP-OES") instruments; raman spectroscopy; cell analysis plate based assays; laboratory software and informatics systems; laboratory automation and robotic systems; dissolution testing; vacuum pumps and measurement technologies.
Net Revenue
| Years Ended October 31, | 2017 over 2016 Change | 2016 over 2015 Change | |||||||||||||
| 2017 | 2016 | 2015 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue | $ | 2,169 | $ | 2,073 | $ | 2,046 | 5% | 1% |
Life science and applied markets business revenue in 2017 increased 5 percent compared to 2016. Foreign currency movements for 2017 had an overall unfavorable currency impact of less than 1 percentage point on revenue growth when compared to the same period last year. Geographically, revenue increased 2 percent in the Americas, increased 7 percent in Europe with a 1 percentage point unfavorable currency impact and increased 5 percent in Asia Pacific. From a product standpoint, gas chromatography mass spectrometry, software and informatics systems, and cell analysis systems led with double digit growth during the year. Gas chromatography returned to strong growth on the strength of rebounding chemical and energy markets. Liquid chromatography grew single digits compared to 2016 as the pharmaceutical markets moderated.
Life science and applied markets business revenue in 2016 increased 1 percent compared to 2015. Strong growth in China led the geographic portfolio during 2016, and helped offset softness in the Americas and Europe. Liquid chromatography products revenue continued solid growth on strength in the pharmaceutical market. Revenue from mass spectrometry had areas of strength, particularly in China, which were offset by continued declines in revenue in the chemical and energy markets as well as diagnostic and clinical market declines in the Americas.
End market performance in 2017 showed a shift in growth trends from those of 2016. Chemical and energy markets rebounded sharply from the depressed levels of 2016 and delivered strong growth. The growth from pharmaceutical markets, which led the way in 2016, was modest reflecting difficult year on year comparisons. Food and environmental markets demonstrated continued growth during the year. Life science research and diagnostic and clinical market sales saw improvement as the year progressed. End market performance reflected mixed growth across markets in 2016. Pharmaceutical market growth was robust in 2016 driven by continuing technology refresh programs. Food and environmental markets, driven by strong sales in China, were areas of good growth in an otherwise weak applied market sector. Chemical and energy markets continued their declines throughout 2016 as oil prices remained low and capital budgets were constrained.
Looking forward, we are optimistic about our growth opportunities in the life sciences and applied markets as our broad portfolio of products and solutions are well suited to address customer needs. We anticipate strong sales funnels given new product introductions as we continue to invest in expanding and improving our applications and solutions portfolio. While we anticipate volatility in our markets, we expect continued growth across most end markets.
Gross Margin and Operating Margin
The following table shows the life sciences and applied markets business' margins, expenses and income from operations for 2017 versus 2016, and 2016 versus 2015.
| Years Ended October 31, | 2017 over 2016 Change | 2016 over 2015 Change | ||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Total gross margin | 60.1 | % | 58.6 | % | 56.2 | % | 2 ppts | 2 ppts | ||||
| Operating margin | 22.5 | % | 20.7 | % | 18.6 | % | 2 ppts | 2 ppts |
| (in millions) | |||||||||||||||
| Research and development | $ | 206 | $ | 195 | $ | 192 | 6% | 2% | |||||||
| Selling, general and administrative | $ | 610 | $ | 590 | $ | 576 | 3% | 2% | |||||||
| Income from operations | $ | 487 | $ | 429 | $ | 380 | 13% | 13% |
Gross margin increased 2 percentage points in 2017 compared to 2016. The increase was due to a combination of moderate price increases, margin improvement initiatives, and reduced logistics costs. Gross margin increased 2 percentage points in 2016 compared to 2015. The exit of our NMR business contributed 1 percentage point to gross margin improvement. Other contributions were the result of reduced warranty costs and improved efficiencies in logistics offset by higher wages and variable pay.
Research and development expenses increased 6 percent in 2017 when compared to 2016. Research and development expenses increased due to higher project investments across our businesses as well as higher wages and variable pay. Research and development expenses increased 2 percent in 2016 when compared to 2015. Acquisitions partially offset savings from the NMR business exit, with growth coming from wage increases, variable pay and targeted investments.
Selling, general and administrative expenses increased 3 percent in 2017 compared to 2016. Selling, general and administrative expenses increased due to higher funding in marketing programs to promote newly released products as well as higher wages and variable pay. Selling, general and administrative expenses increased 2 percent in 2016 compared to 2015. Acquisitions partially offset savings from the NMR business exit, with growth coming from higher wages and variable pay.
Operating margin increased 2 percentage points in 2017 compared to 2016. Operating margin increased due to revenue growth paired with improvements from gross margin initiatives and moderate price increases. Operating margin increased 2 percentage points in 2016 compared to 2015. The exit of our NMR business contributed 2 percentage point to operating margin improvement, with gross margin improvements from lower warranty and logistics costs making up the difference.
Income from Operations
Income from operations in 2017 increased by $58 million or 13 percent when compared to 2016 on a revenue increase of $96 million. The increase was due to higher revenues and lower cost of sales on incremental revenues. Income from operations in 2016 increased by $49 million or 13 percent compared to 2015 on a revenue increase of $27 million. The exit of our NMR division contributed roughly 40 percent of the improvement with revenue growth and improved gross margins making up the difference.
Diagnostics and Genomics
Our diagnostics and genomics business includes the genomics, nucleic acid contract manufacturing and research and development, pathology, companion diagnostics and reagent partnership businesses.
Our diagnostics and genomics business is comprised of five areas of activity providing active pharmaceutical ingredients ("APIs") for oligo-based therapeutics as well as solutions that include reagents, instruments, software and consumables, which enable customers in the clinical and life sciences research areas to interrogate samples at the cellular and molecular level. First, our genomics business includes arrays for DNA mutation detection, genotyping, gene copy number determination, identification of gene rearrangements, DNA methylation profiling, gene expression profiling, as well as next generation sequencing ("NGS") target enrichment and genetic data management and interpretation support software. This business also includes our new acquisition “Multiplicom” a leading European diagnostics company with state-of-the-art genetic testing technology and products. Multiplicom’s solutions enable clinical labs to identify DNA variants associated with genetic disease and help direct cancer therapy.
Second, our nucleic acid solutions business provides equipment and expertise focused on production of synthesized oligonucleotides under pharmaceutical good manufacturing practices ("GMP") conditions for use as active pharmaceutical ingredients ("API") in an emerging class of drugs that utilize nucleic acid molecules for disease therapy. Next, our pathology solutions business is focused on product offerings to cancer diagnostics and anatomic pathology workflows. The broad portfolio of offerings includes immunohistochemistry (“IHC”), in situ hybridization (“ISH”), hematoxylin and eosin (“H&E”) staining and special staining. We also collaborate with a number of major pharmaceutical companies to develop new potential pharmacodiagnostics, also known as companion diagnostics, which may be used to identify patients most likely to benefit from a specific targeted therapy. Finally, the reagent partnership business is a provider of reagents used for turbidimetry and flow cytometry.
Net Revenue
| Years Ended October 31, | 2017 over 2016 Change | 2016 over 2015 Change | |||||||||||||
| 2017 | 2016 | 2015 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue | $ | 772 | $ | 709 | $ | 662 | 9% | 7% |
Diagnostics and genomics business revenue in 2017 increased 9 percent compared to 2016. Foreign currency movements for 2017 had no overall currency impact on revenue growth when compared to the same period last year. Geographically, revenue increased 8 percent in the Americas with a 1 percentage point favorable currency impact, increased 10 percent in Europe with a 1 percentage point unfavorable currency impact and increased 10 percent in Asia Pacific. The growth in the Americas was assisted by continued strength in our nucleic acid solutions division, growth in sales in our pathology business and continuing strong growth in the companion diagnostic business. Pathology growth was a result of strength in all regions led by our companion diagnostics ("CDx") assays and molecular pathology products. Europe results were supported by growth in our genomics, pathology, and the companion diagnostic business. Asia Pacific, our relatively smaller region, increased mainly due to higher shipment volumes in China and Japan.
Diagnostics and genomics business revenue in 2016 increased 7 percent compared to 2015. The performance in Americas and Europe were assisted by growth in sales in genomics (particularly target enrichment and arrays), strength in pathology business, continued demand in the nucleic acid solutions and good momentum in the companion diagnostic business. Growth in Asia Pacific reflected strong growth in China.
The 9 percent revenue growth in 2017 was due to positive growth from all businesses and regions. This was led by revenue growth in the companion diagnostics business working with our pharmaceutical partners. Nucleic acid business saw continued market demand in the nucleic acid solutions business related to therapeutic oligo programs and the pathology business saw steady growth due to strong utilization of Agilent’s Dako OMNIS platform and strength in our PD-L1 assays. The end markets in diagnostics and clinical research remain strong and growing driven by an aging population and lifestyle. The 7 percent revenue growth in 2016 was driven by demand in the nucleic acid solutions, good revenue performance in pathology and companion diagnostics businesses as well as next generation sequencing solution offering within the genomics business.
Looking forward, we are optimistic about our growth opportunities in the diagnostics markets and continue to invest in expanding and improving our applications and solutions portfolio. We remain positive about our growth in these markets, as our Dako OMNIS products, PD-L1 assays and SureFISH continue to gain strength with our customers in clinical oncology applications and our next generation sequencing (target enrichment solutions) continue to be adopted. Market demand in the nucleic acid solutions business related to therapeutic oligo programs continues to be strong. We are investing in building further capacity in our nucleic acid business to address the demand for the oligos. We will continue to invest in research and development, and seek to expand our position in developing countries and emerging markets.
Gross Margin and Operating Margin
The following table shows the diagnostics and genomics business's margins, expenses and income from operations for 2017 versus 2016, and 2016 versus 2015.
| Years Ended October 31, | 2017 over 2016 Change | 2016 over 2015 Change | ||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Total gross margin | 55.1 | % | 54.6 | % | 54.4 | % | 1 ppt | — | ||||
| Operating margin | 19.3 | % | 16.0 | % | 13.3 | % | 3 ppts | 3 ppts |
| (in millions) | |||||||||||||||
| Research and development | $ | 84 | $ | 83 | $ | 78 | 1% | 6% | |||||||
| Selling, general and administrative | $ | 193 | $ | 190 | $ | 195 | 1% | (2)% | |||||||
| Income from operations | $ | 149 | $ | 114 | $ | 88 | 31% | 29% |
Gross margin increased 1 percentage point in 2017 when compared to 2016, mainly driven out of higher volume. Gross margin was flat in 2016 when compared to 2015. Favorable gross margins due to higher volumes were fully offset by unfavorable currency movements.
Research and development expenses increased 1 percent in 2017 when compared to 2016 however reduced 1 percent as a percentage of revenue. The spending increase is related to an acquisition and higher wages and variable pay. Research and development expenses increased 6 percent in 2016 when compared to 2015 however, remained flat as a percentage of revenue. This reflected higher wages and variable pay and increased spending around the development of clinical applications and solutions were partially offset by favorable currency movements.
Selling, general and administrative expenses increased 1 percent in 2017 when compared to 2016. Selling, general and administrative expenses increase was related to additional operating expenses associated with an acquisition and higher wages and variable pay partially offset by reduced expenses due to business improvement initiatives. Selling, general and administrative expenses decreased 2 percent in 2016 when compared to 2015, reflecting favorable currency movements, reduced expenses due to business improvement initiatives partially offset by higher wages and variable pay.
Operating margin increased 3 percentage points in 2017 when compared to 2016. The margin improvement was driven by higher revenue volumes partially offset by adding the cost structure of an acquisition and higher wages and variable pay. Operating margin increased 3 percentage points in 2016 when compared to 2015. The increase was due to higher volumes, efficiency gains in selling, general and administrative costs partially offset by higher wages and variable pay.
Income from Operations
Income from operations in 2017 increased by $35 million or 31 percent when compared to 2016 on a revenue increase of $63 million. The increase was due to higher volumes and controlled expenses. Income from operations in 2016 increased by $26 million or 29 percent when compared to 2015 on a revenue increase of $47 million. The increase was due to higher volumes and reduced selling and general administration expenses.
Agilent CrossLab
The Agilent CrossLab business spans the entire lab with its extensive consumables and services portfolio, which is designed to improve customer outcomes. The majority of the portfolio is vendor neutral, meaning Agilent can serve and supply customers regardless of their instrument purchase choices. Solutions range from chemistries and supplies to services and software helping to connect the entire lab. Key product categories in consumables include GC and LC columns, sample preparation products, custom chemistries, and a large selection of laboratory instrument supplies. Services include startup, operational, training and compliance support, software as a service, as well as asset management and consultative services that help increase customer productivity. Custom service and consumable bundles are tailored to meet the specific application needs of various industries and to keep instruments fully operational and compliant with the respective industry requirements.
Net Revenue
| Years Ended October 31, | 2017 over 2016 Change | 2016 over 2015 Change | |||||||||||||
| 2017 | 2016 | 2015 | |||||||||||||
| (in millions) | |||||||||||||||
| Total net revenue | $ | 1,531 | $ | 1,420 | $ | 1,330 | 8% | 7% |
Agilent CrossLab business revenue in 2017 increased 8 percent when compared to 2016. Foreign currency movements for 2017 had an overall unfavorable impact of less than 1 percentage point when compared to 2016. Revenue growth in 2017 was led by increases in most core services and lab enterprise services and was led in terms of percentage growth by the remarketed instruments business. Geographically, revenue increased 8 percent in the Americas, increased 4 percent in Europe with a 2 percentage points unfavorable currency impact and increased 11 percent in Asia Pacific with a 1 percentage point unfavorable currency impact. Agilent CrossLab business revenue in 2016 increased 7 percent when compared to 2015. Revenue growth in 2016 was led by increases in enterprise service contracts, LC small molecule columns, remarketed instruments, and bio-columns.
Agilent CrossLab business saw positive revenue growth in all the key end markets in 2017, except in the forensics market. In 2017, revenue growth, from a percentage perspective, was led by the food market. The pharmaceutical and biotechnology market in 2017 saw slower growth than in the prior year mostly due to a tougher comparison, but was still the primary growth driver from a volume perspective. The chemical and energy market provided the same level of solid revenue growth in 2017 as in 2016. In 2016, the business saw positive revenue growth in all the key end markets after accounting for the unfavorable currency movements, and was led by the pharmaceutical and biotechnology market, as well as the food market.
Looking forward, we expect balanced strength in nearly all key end markets to drive growth in the near term. Geographically, we remain optimistic on the market growth and market penetration opportunities in China and the emerging markets. Other factors for near term revenue growth include upcoming product launches from our consumables pipeline, as well as on our investment in our laboratory enterprise offerings.
Gross Margin and Operating Margin
The following table shows the Agilent CrossLab business's margins, expenses and income from operations for 2017 versus 2016 and 2016 versus 2015.
| Years Ended October 31, | 2017 over 2016 Change | 2016 over 2015 Change | ||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Total gross margin | 49.5 | % | 49.4 | % | 49.6 | % | — | — | ||||
| Operating margin | 22.1 | % | 22.3 | % | 22.5 | % | — | — |
| (in millions) | |||||||||||||||
| Research and development | $ | 49 | $ | 46 | $ | 46 | 7% | — | |||||||
| Selling, general and administrative | $ | 370 | $ | 339 | $ | 315 | 9% | 7% | |||||||
| Income from operations | $ | 338 | $ | 316 | $ | 299 | 7% | 6% |
Gross margin was flat in 2017 when compared to 2016, due to the higher sales volume offset by higher wages and variable pay. Gross margin was flat in 2016 when compared to 2015, due to the higher sales volume and several margin improvement initiatives which were partially offset by higher wages and variable pay, unfavorable currency movements and less favorable currency hedging results.
Research and development expenses increased 7 percent in 2017 when compared to 2016, due to increased investment related to an acquisition, as well as higher wages and variable pay. Research and development expenses was flat in 2016 when compared to 2015, due to wage increases being offset by moderate favorable currency movements.
Selling, general and administrative expenses increased 9 percent in 2017 when compared to 2016, due to higher orders driving higher selling costs, as well as higher wages and variable pay and the additional operating expenses from an acquisition. Selling, general and administrative expenses increased 7 percent in 2016 when compared to 2015, primarily due to higher orders driving higher field selling costs, higher wages and variable pay and larger investments into marketing and the sales channel.
Operating margin was flat in 2017 when compared to 2016, due to higher sales volume helping to offset growth in the number of service workforce, higher wages and variable pay and higher field selling costs. Operating margin was flat in 2016 when compared to 2015, due to higher sales volume which was partially offset by higher wages and variable pay, unfavorable currency movements less favorable currency hedging results, and increased selling, general and administrative expenses.
Income from Operations
Income from operations in 2017 increased by $22 million or 7 percent when compared to 2016 on a revenue increase of $111 million. This increase was due to higher sales volume, partially offset by higher operating expenses. Income from operations in 2016 increased by $17 million or 6 percent when compared to 2015 on a revenue increase of $90 million. This increase was due to higher sales volume, partially offset by currency and higher operating expenses.
Financial Condition
Liquidity and Capital Resources
Our financial position as of October 31, 2017 consisted of cash and cash equivalents of $2,678 million as compared to $2,289 million as of October 31, 2016.
As of October 31, 2017, approximately $2,600 million of our cash and cash equivalents is held outside of the U.S. by our foreign subsidiaries. Most of the amounts held outside of the U.S. could be repatriated to the U.S. but, under tax law effective through our 2017 fiscal year-end, would be subject to U.S. federal and state income taxes, less applicable tax credits. Agilent has accrued for U.S. federal and state tax liabilities on the earnings of its foreign subsidiaries except when the earnings are asserted as indefinitely reinvested outside of the U.S. Repatriation could result in additional material U.S. federal and state income tax payments in future years. In 2017, we assessed our overall cash needs and funding sources and determined a portion of our current year foreign earnings from our low-tax jurisdictions would be repatriated, the timing of which is dependent upon the recently passed U.S. tax legislation. We utilize a variety of funding strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed.
We believe our cash and cash equivalents, cash generated from operations, and ability to access capital markets and credit lines will satisfy, for at least the next twelve months, our liquidity requirements, both globally and domestically, including the following: working capital needs, capital expenditures, business acquisitions, stock repurchases, cash dividends, contractual obligations, commitments, principal and interest payments on debt, and other liquidity requirements associated with our operations.
Net Cash Provided by Operating Activities
Net cash provided by operating activities was $889 million in 2017 as compared to $793 million provided in 2016 and $512 million provided in 2015. We paid approximately $63 million of net taxes in 2017, as compared to $67 million in net taxes in 2016 and net taxes of $129 million in 2015. The decrease in taxes paid for the year ended October 31, 2016 compared to 2015 was primarily due to taxes paid related to the separation of Keysight in 2015 and to a lesser extent due to some tax refunds. Cash paid for income taxes for the year ended October 31, 2015, included tax payments related to the separation of Keysight. For the years ended October 31, 2017, 2016 and 2015, other assets and liabilities used cash of $98 million, provided cash of $10 million and used cash of $249 million, respectively. The increase in cash usage for the year ended October 31, 2017 in other assets and liabilities is primarily due to pension contributions and taxes.
In 2017, the change in accounts receivable used cash of $81 million, $33 million in 2016, and $24 million in 2015. Days' sales outstanding as of October 31, were 55 days in 2017, 51 days in 2016 and 53 days in 2015. The change in accounts payable provided cash of $2 million in 2017, used cash of $15 million in 2016 and used cash of $26 million in 2015. Cash used in inventory was $61 million in 2017, in $7 million in 2016 and $24 million in 2015. Inventory days on-hand increased to 95 days in 2017 compared to 92 days in 2016 and decreased compared to 97 days in 2015.
We contributed $25 million, zero and $15 million to our U.S. defined benefit plans in 2017, 2016 and 2015, respectively. We contributed $21 million, $24 million and $25 million to our non-U.S. defined benefit plans in 2017, 2016 and 2015, respectively. We contributed less than $1 million in 2017, 2016 and 2015 to our U.S. post-retirement benefit plans. Our non-U.S. defined benefit plans are generally funded ratably throughout the year. Total contributions in 2017 were $46 million or 92 percent more than 2016. Our annual contributions are highly dependent on the relative performance of our assets versus our projected liabilities, among other factors. We do not expect to contribute to our U.S. plans and expect to contribute $22 million to our non-U.S. defined benefit plans and nothing to our U.S. post-retirement benefit plans during 2018.
Net Cash Used in Investing Activities
Net cash used in investing activities in 2017 was $305 million and in 2016 was $238 million as compared to net cash used of $400 million in 2015.
Investments in property, plant and equipment were $176 million in 2017, $139 million in 2016 and $98 million in 2015. Proceeds from sale of property, plant and equipment were zero in 2017 and 2016, and $12 million in 2015. In 2017 we invested $128 million in acquisitions of businesses and intangible assets, net of cash acquired compared to $261 million in 2016 and $74 million in 2015. In 2017 there were approximately $1 million purchases of cost method investments compared to $80 million outlay in 2016 and zero in 2015. Change in restricted cash and cash equivalents was $1 million outflow in 2017, $245 million inflow in 2016 and $240 million outflow in 2015, respectively (changes in 2016 and 2015 related to our Seahorse Biosciences acquisition).
Net Cash Used in Financing Activities
Net cash used in financing activities in 2017 was $202 million compared to $268 million in 2016 and $1,089 million in 2015, respectively.
Treasury Stock Repurchases
On November 22, 2013 we announced that our board of directors had authorized a share repurchase program. The program was designed to reduce or eliminate dilution resulting from issuance of stock under the company's employee equity incentive programs to target maintaining a weighted average share count of approximately 335 million diluted shares. For the year ended October 31, 2015 we repurchased 6 million shares for $267 million. For the year ended October 31, 2016 we repurchased approximately 2.4 million shares for $98 million which completed the purchases under this authorization.
On May 28, 2015 we announced that our board of directors had approved a new share repurchase program (the "2015 repurchase program"). The 2015 share repurchase program authorizes the purchase of up to $1.14 billion of our common stock at the company's discretion through and including November 1, 2018. The 2015 repurchase program does not require the company to acquire a specific number of shares and may be suspended or discontinued at any time; however, we plan to repurchase a minimum of 674,000 shares per quarter in fiscal year 2018. Any additional repurchases may be impacted by our share price as well as other market conditions. During the year ended October 31, 2016, upon the completion of our previous repurchase program, we repurchased approximately 8.3 million shares for $336 million under this authorization. During the year ended October 31, 2017 we repurchased approximately 4.1 million shares for $194 million under this authorization. As of October 31, 2017, we had remaining authorization to repurchase up to $610 million of our common stock under this program.
During fiscal year 2017, we retired 294.2 million treasury shares at an aggregate cost of $10.7 billion, the amount of which represents all of our previously repurchased shares over the past 12 years including 2017 repurchases. Also the retirement resulted in a decrease of $6.7 billion to retained earnings and a decrease of $4.0 billion to additional paid-in-capital.
Dividends
For the years ended October 31, 2017, 2016 and 2015 cash dividends of $170 million, $150 million and $133 million were paid on the company's outstanding common stock, respectively. On November 15, 2017 we declared a quarterly dividend of $0.149 per share of common stock, or approximately $48 million which will be paid on January 24, 2018 to shareholders of record as of the close of business on January 2, 2018. The timing and amounts of any future dividends are subject to determination and approval by our board of directors.
Credit Facility
On September 15, 2014, Agilent entered into a credit agreement with a financial institution which provides for a $400 million five-year unsecured credit facility that will expire on September 15, 2019. On June 9, 2015, the commitments under the existing credit facility were increased by $300 million and on July 14, 2017, the commitments under the existing credit facility were increased by an additional $300 million so that the aggregate commitments under the facility now total $1 billion. As of October 31, 2017, the company had $110 million outstanding under the facility. We were in compliance with the covenants for the credit facility during the years ended October 31, 2017 and 2016.
Short-term and Long-term Debt
In October 2007, the company issued an aggregate principal amount of $600 million in senior notes ("2017 senior notes"). On October 20, 2014, we settled the redemption of $500 million of the $600 million outstanding aggregate principal amount of our 2017 senior notes. The remaining $100 million in senior notes matured and were paid in full on November 1, 2017.
In July 2010, the company issued an aggregate principal amount of $500 million in senior notes ("2020 senior notes"). The 2020 senior notes were issued at 99.54% of their principal amount. The notes will mature on July 15, 2020, and bear interest at a fixed rate of 5.00% per annum. The interest is payable semi-annually on January 15th and July 15th of each year, payments commenced on January 15, 2011.
On August 9, 2011, we terminated our interest rate swap contracts related to our 2020 senior notes that represented the notional amount of $500 million. The asset value, including interest receivable, upon termination for these contracts was approximately $34 million and the amount to be amortized at October 31, 2017 was $11 million. The gain is being deferred and amortized to interest expense over the remaining life of the 2020 senior notes.
In September 2012, the company issued an aggregate principal amount of $400 million in senior notes ("2022 senior notes"). The 2022 senior notes were issued at 99.80% of their principal amount. The notes will mature on October 1, 2022, and bear interest at a fixed rate of 3.20% per annum. The interest is payable semi-annually on April 1st and October 1st of each year, payments commenced on April 1, 2013.
In June 2013, the company issued aggregate principal amount of $600 million in senior notes ("2023 senior notes"). The 2023 senior notes were issued at 99.544% of their principal amount. The notes will mature on July 15, 2023 and bear interest at a fixed rate of 3.875% per annum. The interest is payable semi-annually on January 15th and July 15th of each year and payments commenced January 15, 2014.
On September 15, 2016, the company issued aggregate principal amount of $300 million in senior notes ("2026 senior notes"). The 2026 senior notes were issued at 99.624% of their principal amount. The notes will mature on September 22, 2026 and bear interest at a fixed rate of 3.050% per annum. The interest is payable semi-annually on March 22nd and September 22nd of each year and payments commenced March 22, 2017.
In February 2016, Agilent executed three forward-starting pay fixed/receive variable interest rate swaps for the notional amount of $300 million in connection with future interest payments to be made on our 2026 senior notes issued on September 15, 2016. The swap arrangements were terminated on September 15, 2016 with a payment of $10 million and we recognized this as a deferred loss in accumulated other comprehensive income which is being amortized to interest expense over the life of the 2026 senior notes.The remaining loss to be amortized related to the interest rate swap agreements at October 31, 2017 was $9 million.
Off Balance Sheet Arrangements and Other
We have contractual commitments for non-cancelable operating leases. See Note 15, "Commitments and Contingencies", to our consolidated financial statements for further information on our non-cancelable operating leases.
Our liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and some of which arise from fluctuations related to global economics and markets. Our cash balances are generated and held in many locations throughout the world. Local government regulations may restrict our ability to move cash balances to meet cash needs under certain circumstances. We do not currently expect such regulations and restrictions to impact our ability to pay vendors and conduct operations throughout our global organization.
Contractual Commitments
Our cash flows from operations are dependent on a number of factors, including fluctuations in our operating results, accounts receivable collections, inventory management, and the timing of tax and other payments. As a result, the impact of contractual obligations on our liquidity and capital resources in future periods should be analyzed in conjunction with such factors.
The following table summarizes our total contractual obligations at October 31, 2017 for Agilent operations and excludes amounts recorded in our consolidated balance sheet (in millions):
| Less than one year | One to three years | Three to five years | More than five years | ||||||||||||
| Operating leases | $ | 42 | $ | 52 | $ | 16 | $ | 26 | |||||||
| Commitments to contract manufacturers and suppliers | 384 | 4 | — | — | |||||||||||
| Other purchase commitments | 40 | — | — | — | |||||||||||
| Retirement plans | 22 | — | — | — | |||||||||||
| Transitional pension contributions to our U.S. 401(k) plan | $ | 8 | $ | 15 | $ | 12 | $ | — | |||||||
| Total | $ | 496 | $ | 71 | $ | 28 | $ | 26 |
Operating Leases. Commitments under operating leases relate primarily to leasehold property, see Note 15, "Commitments and Contingencies".
Commitments to Contract Manufacturers and Suppliers. We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, we issue purchase orders with estimates of our requirements several months ahead of the delivery dates. The above amounts represent the commitments under the open purchase orders with our suppliers that have not yet been received. However, our agreements with these suppliers usually provide us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. We expect to fulfill most of our purchase commitments for inventory within one year.
In addition to the above mentioned commitments to contract manufacturers and suppliers, in the past we recorded a liability for firm, non-cancelable and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with our policy relating to excess inventory. As of October 31, 2017, the liability for our firm, non-cancelable and unconditional purchase commitments was $1 million compared to less than $1 million as of October 31, 2016 and $5 million as of October 31, 2015. These amounts are included in other accrued liabilities in our consolidated balance sheet.
Other Purchase Commitments. We have categorized "other purchase commitments" related to contracts with professional services suppliers. Typically, we can cancel contracts without penalties. For those contracts that are not cancelable without penalties, we are disclosing the termination fees and costs or commitments for continued spending that we are obligated to pay to a supplier under each contact's termination period before such contract can be cancelled. Our contractual obligations with these suppliers under "other purchase commitments" were approximately $40 million within the next year.
Retirement Plans. Commitments under the retirement plans relate to expected contributions to be made to our U.S. and non-U.S. defined benefit plans and to our post-retirement medical plans for the next year only. Contributions after next year are impractical to estimate. Effective May 1, 2016 until April 30, 2022, we will provide an additional transitional company contribution for certain eligible employees equal to 3 percent, 4 percent or 5 percent of an employee's annual eligible compensation due to the U.S. Retirement Plan benefits being frozen.
We had no material off-balance sheet arrangements as of October 31, 2017 or October 31, 2016.
On Balance Sheet Arrangements
The following table summarizes our total contractual obligations at October 31, 2017 related to our debt and interest expense (in millions):
| Less than one year | One to three years | Three to five years | More than five years | ||||||||||||
| Senior notes | $ | 100 | $ | 500 | $ | 400 | $ | 900 | |||||||
| Credit facility(1) | 110 | — | — | — | |||||||||||
| Interest expense | 74 | 141 | 90 | 61 | |||||||||||
| Total | $ | 284 | $ | 641 | $ | 490 | $ | 961 |
(1) The credit facility expires on September 15, 2019.
Other long-term liabilities include $131 million and $190 million of liabilities for uncertain tax positions as of October 31, 2017 and October 31, 2016, respectively. We are unable to accurately predict when these amounts will be realized or released. However, it is reasonably possible that there could be significant changes to our unrecognized tax benefits in the next twelve months due to either the expiration of a statute of limitations or a tax audit settlement.
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