安捷倫 (A) 2002 Q2 法說會逐字稿

Please standby. The conference is about to begin. Good day and welcome to the Agilent second quarter earnings conference call. This call is being recorded. At this time for opening remarks and introduction, I would like to turn the call over to the Investor Relations, Director Mr.Hilliard Terry. Please go ahead, Sir.

Thanks and welcome to Agilent second quarter conference call. With me are Agilent CEO Ned Barnholt, and CFO Adrian T.Dillon. After my introductory comments, Ned will provide his perspective on our performance this quarter and on the macro environment. Then Adrian will provide a detailed commentary on the financials. After that we will open it up for questions. In case you haven't had a chance to review the release, you can find it on our website at www.investor.agilent.com. I would like to remind you that in our prepared remarks and in our answers to your questions, we will make forward-looking statements that will involve risks and uncertainties. These risks and uncertainties could cause Agilent's results to differ materially from management's current expectations. We encourage you to look at the company's most recent filings with the Securities and Exchange Commission to get a more complete picture of all the factors at work. Finally, I should mention that the guidance we will provide today is only the time we give it. The company assumes no obligations to update the guidance provided on this call as we move through the quarter. With that, I will turn the call over to Ned.

Thanks, HIlliard and Good afternoon everyone. We appreciate you joining us to review a pretty good quarter in which our results were largely in line with the plan we have set. There are few things to keep in mind as Adrian and I go through the results. First the market trends we told you about at the end of first quarter continue this quarter with semi conductor products and semi conductor tests on the front-end of a gradual recovery. Second, we are making progress on the cost reductions and operational improvements we are implementing.

Compared to a year ago, for example, operating expenses are lower by about a $175m on a quarterly basis. Total regular employment is down by about 6,000 people. And we will complete our previously announced total reduction of 8,000 people by year-end. We remain committed to the savings goals we have outlined for you previously. Finally, new products are making a real difference. They are contributing to the top line in helping us on market shares well. Our revenue of $1.5b and earnings before goodwill loss of $0.24 per share in the middle of the guidance range we provided. We have got a little help on EBG from a change in the tax rate which Adrian will describe. On orders we achieved a 9 percent sequential increase and 14 percent growth over second quarter last year. This is our first year over year increase in orders in 5 quarters. You will recall that in orders in second quarter last year, we reduced by about $500m in cancellations as the downturn became severe. This quarter cancellations were about $90m, very close to last quarter.

In test and measurement, orders in semi conductor 9 percent over a very strong first quarter with demand in semi conductor contract manufactures continuing and a nice pick up in orders from Integrated Device Manufactures. We had 44 design wins in our semi conductor test business this quarter. Our communication test business achieved 10 percent sequential growth this quarter in an overall market where there continues to be a lot of dues. The bottom line is that customers remain conscious and pricing pressures are persistent. The wireless test market is recovering slowly and the wire line market continues to struggle. In general-purpose test, orders were flat overall with the Aerospace defense market as the main break . Semi conductor products orders grew 38 percent over first quarter with excellent growth in personal systems and networking. Orders in life sciences and chemical analysis business were basically flat sequentially but grew 8 percent over second quarter last year. In the life science portion of this business, orders were up 4 percent sequentially and 10 percent compared with second quarter last year. We achieved this growth in an environment where pharmaceutical companies are releasing their capital budget later than in prior years and where the general trend is for these budgets to be flat compared to last year.

We have said in the past that strong new products are the key to winning business in a tough environment and we are continuing to focus on new product introductions. We are quite pleased with our customers responding to our new offerings even in those markets where overall demand remains sluggish. New products have been a major focus as we navigated the downturn and prepared for better times. Our emphasis on innovative new products has helped the top line and enabled us to achieve market share gains. An example is in semi conductor products where we believe we made substantial gains in our share in fiber optic market for storagery and networks. Our optical computer mouse and F4 filter products are increasing their share by displacing Legacy Technologies. Overall our market increases are a good measure of the new products and we will continue to focus on new products rollouts through the second half of the year. We are also working to achieve the cost structures we need. A key part of this effort of is the work force management program I mentioned. As you know, our plan is to reduce our work force by about 8,000 people by the end of the year. We will complete this program as we wrap up a number of projects including some outsourcing, a number of manufacturing consolidations, a to transfer here in the US, and other efforts.

Work force management is one element of our plan to improve our cost structures long term. Another is a range of actions we have been taking during the last 3 years to make Agilent faster and more responsive by streamlining our processes. We have consolidated from 42 manufacturing sites and we are planning to get fewer than 20. We have restructured TN for structural function such as HR facilities management and IT and we have recently launched a major transformation initiative in finance. We also have a major operational transformation that has been, that has a key milestone coming up this quarter. This is the ERP implementation that we have discussed with you in the past. On June 12th, we will go live with the first phase of this system. This launch is focused on our order management function, some large manufacturing sites and related supply chain activities and all our finance. Although the manufacturing sites involve account for more than half of our total revenue. We are working closely with customers and it is very hard internally to make this transition as smooth as we can. The testing we have been doing has gone very well. We have processes in place and thousands of people trained on the new systems. We believe we can do an excellent job in this ambitious project. There is substantial upside for Agilent and our customers from the ERP project. The new system will generate real time information that our people and customers need. This will enable our people to share information much more easily that we can do today. It will improve our ability to manage assets. The June launch is a major step these improvements. We expect to realize significant savings from this project beginning in fiscal 2003. We also have recently decided to accelerate our schedule for moving from HP's customers and support systems. This was a mutual decision between our two companies. HP wants to focus on the compact integration and we want to tailor our systems to Agilent's needs. Our plan calls for us to complete this separation by early December. We estimate that we will spend about $75m over the next 9 months separate from what we are spending on the ERP effort to achieve independence in this area. We also expect a pretty fast return on this investment starting in the first quarter of fiscal 2003.

I want to mention a management change that we recently announced. John Scruggs who has led our automatic test business so capably has decided to retire after 29 years with HP and Agilent. All of us have worked with John and benefited from his experience and insights and we will miss having him as part of our senior management team. John's successor is Jack . Jack has most recently been leading our OSS business and he brings to this new role great skills and a wealth of experience including 12 years in the automated test group. I want to emphasis that we are going to find a replacement for Jack as quickly as possible and we remain committed and very enthusiastic about the OSS market and the progress we are making with our integrated platform. So to summarize, we made good progress this quarter on restoring Agilent in financial help and strengthening the company for the long term. We are addressing challenges in the marketplace and we are implementing ambitious programs internally to strengthen our processes and improve our costs. I will conclude my remarks with a few thoughts on the outlook.

the environment in the telecom market remains difficult and will stay that way for sometime. The CAPEX spending reductions that have been announced as well are well documented and will continue to affect roughly 20 percent of Agilent's business that serves this market. We are also seeing increased pricing pressure in the broader communications and electronics market and we expect this to continue as well. There is intense competition for the business that is out there. In this environment the steps we are taking will continue to serve us well. The second half of the year will be very strong for new products and we are moving rapidly to improve our cost structure for the long term with our ERP project the major focus. Finally we will implement the rest of our work force management program as well as selective actions to make Agilent faster and more cost effective. Given all these factors, we expect to achieve revenue in the third quarter between $1.5 and $1.6b. We believe our earnings before goodwill will come in at a loss of between $0.10 and $0.20 per share. This EBG guidance includes the impact of about $0.05 per share from the June 12 implementation of our company wide ERP system and our project to achieve independence from HP in the customer support area.

Regarding guidance for fourth quarter, at this point we are comfortable with the range of estimates on revenue and earnings. We are determined and we believe we are on track to achieve profitability in the fourth quarter. I am confident that we can meet these goals. We are firmly committed to achieving them and doing all we can to exceed them. We have outstanding products and technologies; we are moving forward aggressively on our work to improve our cost structures and to lower expenses. We have outstanding people who are working very hard to get the company to where we need to be as quickly as we can. Thanks again for joining us today and I will turn it over to Adrian.

Thank you, Ned and Good Afternoon everyone. I am going to tell some financial highlights before we open up it for questions. Overall, we are pleased with Agilent's performance during the quarter. Thinking back to 3 months ago, we provided guidance for revenue of about $1.45 to $1.55b and EBG earnings loss of $0.20 to $0.30 per share. Compared to that guidance, we came in just about the bottom of the range for revenue at $1.46b in revenue but in about the middle of our guidance for earnings at a $0.24 loss. If you look at our performance on a year-to-year basis, the results of the tough actions we have taken over the past year have definitely reduced our normally very heavy profit detrimental. Instead of dropping profits of about $0.75 for every dollar of revenue declined, our detrimental performance over the past year was only $0.27 loss for every incremental dollar decline. And in fact, quarter-to-quarter, despite the seasonally higher labor and marketing costs that you normally see between the first and the second quarter, our incremental profit on our modestly higher revenues was a very attractive 70 percent. So these perspectives give us some confidence that we are generally on track with our expectations for performance and forgetting Agilent is back to profitability by the fourth quarter of this year.

Looking now at the income statement, a few highlights. Net orders at $1.6b, were up 9 percent sequentially and were up 14 percent from a year ago, second consecutive sequential increase and the first time we have been able to say orders are up year to year since the beginning of 2001. Cancellations as Ned already mentioned were about flat in the second quarter at $90m but obviously dramatically better than the $50m cancellations that we experienced last year.

Revenues at $1.46b were up a very modest 2 percent, were up for the first time in 6 quarters, otherwise clearly still very depressed down 39 percent from where we were last year at this time.

That translates into a book to bill of 1.10 for the second quarter, our second consecutive quarter above 1 and improved from the 1.03 that we had in the first quarter of this year.

Turning now to gross margins, we achieved a gross margin of about 42.4 percent, essentially flat with the first quarter and down about 1.4 points from last year. Looking at the gross margins comparison sequentially, mix had a impact of reducing margins by about a quarter point, and the seasonality in a our labor expense between the free time off vacation pay and which effect a vast majority of our work force. That affected that gross margin by roughly one point. Obviously, adjusting for that we would have had a one and a quarter points higher gross margin. In fact very conservatively, there is normally about $40 million seasonal increase in total cost between the first and second quarter, or about 2.5 points of operating margin. That is why under normal circumstances we like to look at comparisons on a year-to-year rather than sequential basis. But even if you ignore the normal seasonal impact we showed for R&D about $285 million in the current quarter, about 19.5 percent of sales and about flat in dollar terms with prior quarter. Compared to last year R&D spending was down about 13 percent. For support cost we had about $552 million, that was down 2 percent from the first quarter and down representative 20 percent from one year ago.

Looking at our tax rate, you will see that we had an effective tax rate of 45 percent in the second quarter. That results from a change in our effective tax rate for the entire year. Last time we talked we were talking about 41 percent tax benefit for the entire year that has now been changed to 43 percent for the full year. The second quarter impact of that change was $0.2. The reason we changed the tax rate is as we mentioned previously we have been doing work on the R&D tax credit, a major study, and we were able to complete that work sooner than we anticipated and with results that are attractive as we anticipated, that is a two point drop in our effective rates. Now that doesn't effect our going forward fiscal 2003 rate of 31 percent that we lowered last time we talked to you because we had assumed that we were going to get those benefits. What we are doing today is just confirmation that that rate is the appropriate rate not only going forward but for this year as well. So you add all that up and we have earnings before goodwill of a loss about $112 million, or $0.24 per share. If you add back the change in the tax rate that makes it $0.26 per share loss that compares with $0.29 Performa loss in the first quarter of the year.

Bridging from Performa to GAAP, we had about $95 million of non-cash goodwill and intangible charges, restructuring expenses of $35 million and taxes and miscellaneous charges of about $11 million, which would get you to a GAAP net earnings of a loss $253 million, which is down substantially from the $315 million loss we had in the first quarter. Our second quarter loss per share basis is $0.55 compared to $0.68 loss in the earlier quarter.

Turning now to the balance sheet and cash flow, in the second quarter we continued to make good progress in managing our balance sheet and minimizing cash consumption. In fact if you look at our cash flow statement, which we are now providing you on a quarterly basis for the first time, you can see that we had a GAAP loss of $247 million and the net cash used in operations was less than half that amount or $118 million. In fact if you exclude the $76 million pension contribution that we made in the second quarter and the $55 million of cash restructuring charges that we took in the second quarter, what you would find is that net cash used in operations was actually a positive $13 million, that is before capital spending we were essentially at a cash breakeven in the second quarter, which we think shows dramatic improvement. Our cash balance in fact at the end of the quarter was $2.235 billion that is up $47 million from the first quarter.

Looking at working capital our receivables did go up by $96 million, our DSOs went up just a touch four days to fifty-six days. Frankly, that is a sign of health. Our DSOs are always under very good control. This is no exception. We had a surge in business in the last two weeks of the quarter. So we have a lot of receivables out there that haven't been collected yet, but it is a manifestation that we had a pretty good April.

Inventories at $1.3 billion were down $71 million. Meaning that we generated $71 million of cash from better performance in the inventories. Ours days on hand dropped from 154 days in the first quarter to 142 days, a 12-day improvement. In the categories still at receivables for the second consecutive quarter, there were no material write offs of inventories.

In CAPEX, we had capital spending of $86 million in the second quarter. That is down nearly $200 million from the spending we had in last year's second quarter. Depreciation was about $90 million about the same as in the first quarter.

Now let me give you a little bit of a segment highlights before we change it back to Hilliard. Starting first with test and measurement. Test and measurement orders of $836 million were about flat up less than 1 percent from the first quarter and down 10 percent from a year ago. Revenues were $814 million, down 1 percent from the first quarter, and the pro forma operating profit loss was $218 million, down from the $229 million loss of the first quarter. Notice, that the profits were up $11 million despite $8 million lower revenues. As we talked about before the normal seasonal increase was the cause.

were at $355 million, was up about 10 percent sequentially but still of 22 percent from a year ago. The star of the sector for the second quarter in a row was test with orders of $167 million, up 9 percent sequentially and up nearly 500 percent from a year ago.

Finally a general-purpose test was at $314 million, down about 12 percent sequentially and still down 30 percent from a year ago. The color I would give you on the segment is pretty much as Nedd had to say, which was that orders in wire line markets coming from optical components and network equipment manufacturers continues to be quite weak. The wireless test market continues to show slow recovery in all regions except Asia, where we have had even more spring. In semi conductor test the news really is that the strength we had seen in semi conductor contract manufacturers ha now been extended to integrate a device manufacturers and is also becoming more broad based, in other words including parametric test and SOC.

For semiconductor products, we had orders of $476 million in the second quarter, up 38 percent from the first quarter and up 138 percent from a year ago. Revenues at $371 million were up 13 percent but were still down 18 percent from a year ago. Our book to bill in semiconductor products was a very attractive 1.28 percent, up from the 1.06 in the first quarter of this year. Performa operating profits were at a loss of $26 million, which was half the loss that we saw in the first quarter of this year. That says we had an incremental profit in capital-intensive business of about 55 percent.

Looking at the details of orders, our networking business was up 20 percent in orders at $142 million. That is the business that serves the servers, switches, , and optical transport equipment markets. Even more strength was shown by our personal systems business at $334 million, it was up 46 percent sequentially. With strength in the optical, , PCs, PAs and mobile phones, and as you can see up 86 percent from a year ago.

Finally in life sciences, we had orders that were about flat with the first quarter at $285 million, but were up 8 percent from last year at this time. Revenues at $272 million were off 2 percent from the first quarter and off about 6 percent from a year ago. The Performa operating profit in the second quarter was $25 million that is down from $38 million in the first quarter because of the seasonality of operating expenses. When you look at it on a year-to-year basis, you can see that our profits were up $5 million from a year ago on $18 million lower revenues. We think that is good performance. The color on this segment would be that business remains about 40 percent life sciences and about 60 percent chemical analysis, and that orders for life science were up about 10 percent year over year and were up about 4 percent sequentially.

For chemical analysis, orders were up about 5% YtoY but were down slightly sequentially while revenues were down slightly YtoY and about flat sequentially again tied to what is happening in the overall economy.

Turning to guidance, it seems first thing looking at the overall macro environment, it seems pretty clear that the US economy is in the early stages of an expansion and we see a comparable rebound beginning in Asia. But the trends in Agilent's markets as Ned has already made clear remain very mixed. Looking at first the semiconductor markets, we expect them to be about flat YoverY but that means it will be up sequentially throughout the remainder of this year. Inventories probably won't continue to get flushed the way they have over the past year but inventories are still in very good shape, very lean and so we are not concerned about building of inventories and we are looking for modest increases in final demand. Semiconductor tests from the depths of the steepest decline in its history will continue to rise sequentially again this quarter and we think indeed for several more quarters to come in a fairly typical rebound. Tom's will continue to generally lag the new recovery with no significant advance expected before our FY around. Our wireless and metro businesses are showing the most relative strength while the long haul wire line both continue to suffer as Ned has indicated. And finally in our life sciences and chemical analysis business, we see pretty much flat near term in both life sciences and chemical analysis but with some gathering strength by year end as the pharma budgets finally begin to get sorted out and we are beginning to see that and we have begun to pick up orders.

So what does that mean for Agilent? Well first thinking about the top line. If you take the forecast that we just talked about as the basis for our planning and indeed they are just forecast, there is no visibility to speak of, we need to add the increasing returns that we are seeing from the enterprise scale that we have been making in R&D. As Ned suggested, we are increasingly confident that we are going to exceed the very modest overall trend we see in our markets and we are going to be able to outgrow those markets by $150m by 4Q of this year. On the bottom line, we think we are generally on track with our workforce management restructuring programs both in terms of cost and in terms of expected savings.

Now what does that mean for guidance? Before any adjustment for the of our ERP systems, we will be looking at 3Q guidance of about $1.5-1.6b for revenues and earnings before goodwill a loss of $0.05-0.15 per share. The adjustment we are suggesting to that guidance has to do with the one-time costs and the inevitable unknown associated with the June 12th of our major ERP implementation. There will be increased one-time expenses associated with the in 3Q as well as the possibility of some operational as we flip the switch. But in my personal experience anyway, Agilent is as prepared as any company I've seen to minimize any disruptions and to react quickly should any problems arise. In fact, it is because of our confidence, this is going to go pretty well that we have accelerated the move from HP's customer service and support system as Ned also mentioned. So we are conservatively estimating that the incremental one time costs and potential disruptions from this 3Q event are in the range of about a nickel to out EPS guidance. So including that impact, 3Q guidance would be a loss of $0.10 to a loss of $0.20 per share. For 4Q even including the residual impact of the ERP related spending, we are comfortable with the range of investor estimates, which on average do call for Agilent to return to profitability for the quarter.

With that, I will turn things back to Hilliard for questions.

Thanks Adrian. Operator, at this time we are ready for questions. Now for the first round, we will limit the questions to one question per person. After we circle around everyone, we will then have time for more questions. Thanks.

Thank you, Sir. The question and answer period will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touchtone telephone. We will proceed in the order that you and we will take as many questions as time permits. Once again, please press star one on your touch tone telephone to ask a question. We will pause for just a moment to give everyone an opportunity to signal the question.

And we will take our first question from Edward White of Lehman Brothers. Please go ahead.

Thank you. I was wondering if you could talk about the long-term impact you expect to get from the separation of HP's customer service and support mechanism. Are there any financial or cost benefits you will get there? Any operational benefits?

Ed, it is Adrian Dillon. Yes indeed, we do expect operational benefits, customer benefits, and financial benefits. The systems that we have had were built long ago. They are custom built. They were part of the HP legacy and it has been a real tangle trying to support those systems and frankly quite expensive to support those systems and use those systems even while we are trying to move over to an integrated ERP with Oracle and so the decision to do this has a very quick pay-back. It is really under a year and the visibility that our customers will have and the quality of the service that they will be able to get from us from being able to use these integrated and state-of-the-art systems will be very substantial.

Ed, in addition I think this will really allow us to tie our product support businesses and our product systems businesses together and we think that is going to be a really powerful opportunity for us to sell more services and support businesses. As Adrian said, there is a very quick payback. Obviously, we no longer have to pay the money to HP to support these systems but in addition to that, we spend a lot of money inside Agilent's to assist and support of these legacy systems. I don't think we are prepared to quantify that yet but as we get closer to 2003, we will tell you what the impact is going to be on our 2003 numbers.

Okay thank you.

We go next to Robert Maire of Bear Stearns. Please go ahead.

Yes. You indicated that in the semiconductor test, you were up 9% sequentially and if I recall correctly, last quarter, you were up substantially more on a percentage basis. Was that because we were on kind of the small numbers that we had a large balance off of the relatively small number? Maybe you could give us kind of an idea as to absolute dollar increases and related to that, you had also previously given us percentage increases on the semiconductor side. Perhaps, I don't know if I missed that but maybe you could give us a similar sort of insight into that.

Robert, you are right. If you go back and look at the 4Q (don't have it right here but I think somebody is looking it up) number for the semiconductor's test was still quite low and we started to see some recovery in 1Q which first drove the percent growth to a reasonably high number. What has happened now is that we have come up to a higher plateau and we are seeing additional gains beyond that but not where near as spectacular as that 1Q as we bounced off the bottom.

In absolute dollars, will you order higher this quarter or lower this quarter?

They are higher. They were 9% higher at $67m.

Okay.

In fact we went from $53m in 1Q to $167m in 2Q for a growth of 9%.

Got it.

And in fact if you go back to 4Q, I just got that number, it was $60m. So we went from $60m to $153m to $167m.

And on the semiconductor side?

What was the question on semiconductors?

I don't know if I heard the percentages have increased between the wireline and wireless. those numbers previously.

No, we break out the business between and personal systems in our semiconductor products and networking was up 20% sequentially and the personal systems business was up 46% sequentially.

Okay. Very good. Thank you.

There continues to be expansion in China and another parts of Asia. I think we have also seen the impact of cdma2000 and in the United States, the move from AT&T and Singular from PDMA to GSF, so there has been some expansion, mostly on the handset side, not as much as on the base station and of course, we still see RAD orders for 3G.

Ned, just wait, you stepped off on the wireless side, what about base station test?

Base station test has been pretty flat and relatively low levels. Again, I think, there is quite a bit of infrastructure out there and we don't see a huge growth, although, its relatively stable level of business in base station test. The other big area, of course, is the optical at transmission test and that one continues to be impacted by what you read in the papers from the wire line service providers, CAPEX is down, component suppliers are generally not investing as well as the big system companies. So that business was actually down slightly, sequentially, for us. We think we are in a very strong product position, it's our unfortunate. We probably have the best RAD Gigabit lineup in the industry. We have breaking products, but right now that market still is suffering from over capacity and I think as you move to the service provider side of the business, we see the same thing with the installation and maintenance business down slightly, not a big growth, but that we are beginning to see, I think, the impact of the capital budget cut backs on a lot of these service providers and then finally, the OSS business tends to be a relatively lumpy business. So we get big orders, one order and not another. I think, we saw a relatively flat performance in OSS business quarter to quarter, but the good news is, we are getting traction on our OSI business. We are continuing to get some new winds in some of the things that had talked about on his conference call earlier this week. We are introducing, in fact, just this week. A number of new products including integrated hybrid, circuit switch and packet switch network management system that integrate our acceSS7 and acceSS NGN. So we are getting a lot of traction and interest in some of these new products, again we remain optimistic and very committed to that business, even though, was relatively flat on a sequential order basis.

Just clarification, you made reference to intense pricing pressure, is that reflected broadly across communication test or whether individual product lines?

No, I think it is pretty much across the board. Actually, it goes all the way from our semiconductor products to our general-purpose test, communication test, and semiconductor test. You know, I think, in general, what we are seeing in this kind of market, there is just a lot of pricing pressure as lot of people are trying to try for every order that's out there.

We will go next to Barry Lebovits of Morgan Stanley, please go ahead.

Hai guys, first question on the enterprise side. Are you seeing stabilization on the enterprise side? Can you give some colors as to what you are seeing on IT budget and what you are seeing from your transceiver business specifically? I guess all this hold at one question.

Well, Barry, you know as I said for some time, I think we saw the recovery first in the consumer side of the electronic market, which has been driving quite a bit of our semiconductor test business. We saw the beginnings of a sequential increase in the first quarter in our networking component business. It was up single digits, but up 20 percent in second quarter over the first quarter and that was largely driven by our fiberoptics business, where it's partly a market stabilization and a little bit of a market expansion. I think it is also attributed to the fact that we are gaining share particularly in the two Gigabit fiberoptic areas. As you know, we were first to market with two Gigabit and we feel that we have a very strong offering there and we are gaining share in some of these networking component areas.

Ned, can you talk for a second about some of your customers on the trends you reside, on the fiber channel side, specifically?

Well, I don't think I am authorized to give out specific names, but let me just tell you that. We estimate on the local area networking side, we probably have somewhere around 50 to 60 percent market share and with that kind of market shares, you can pretty well guess that our customers are the of the networking industry.

We go next to Richard Chu of SG Cowen Securities, please go ahead.

Thank you. I wonder whether you can clarify the gross margin picture a little bit. Were there any impacts this quarter from inventory obsolescence charges either taken in the quarter or a reversal of prior charges? And then when you talked about the ERP and HP impact, which sounds like around 40 to 50 million dollar pre tax, is that predominantly HP driven or is it the one-time ERP in fact and why would you not have gone about the ERP impact previously?

Richard, let me try the first one at least, which is that there were no material write offs of inventories this quarter or last quarter.

You don't reverse those prior reserves?

No significant reversals are prior either. They was unchanged from the prior quarter and on the move to get independent of the HP sale, support, and service business, there is both the cost of the transaction processing and the inherent complications of custom-built software and firmware that really is a heritage a long time ago and we get benefits from that. Eventually we are going to have to get off of those old custom-built systems and that was if you will the third phase or future state of the ERP system, but it was not in the initial estimates of what we are going to be doing. Our level of confidence is such that, in our ERP implementation, that we decided to accelerate that so that we could bring those savings forward and get the efficiencies as well as the customer benefits from having in integrated system.

Can you tell whether this was , the incremental numbers?

The incremental cost will show up mostly in our .

Okay, great, thank you I will come back .

We go next to Steven of Meconia , please go ahead.

Yes. Hai there. Sort of continue on the gross margin, if you could just repeat, Ned or Adrian, the specific areas where you saw pricing pressure and you straight away assumed the primary driver to why there seems to be little pressure on gross margin and then what is the outlook on that dynamics?

What we said in looking at the sequential comparison, which I assume what we are doing of gross margins, we had about one quarter of a point from mix, for example the semiconductor products business, which is our strongest business, this quarter also has a relatively low gross margin and a very low support-expense structure to it and so if you would have just held the mix of our business is constant, you would have seen a quarter-point improvement in our gross margin. More importantly, is the seasonality between the first and the second quarter, where you are adding in for us expense on literarily on all of the US employment that you didn't have for significant portion of the prior quarter as well as vacation pay versus more time with people in the facilities, again comparison between our first and our second quarters, that was what that brought the percentage point in the gross margin. Now more generally on your question about pricing pressure, it is, as Ned said across the board there isn't anything, anyone business as being specifically or predominantly slammed. It is tough all over out there. There are companies that are literally struggling to survive and they are trying to buy business and at times we have to respond. We don't expect that to get any better in the foreseeable future.

Then I guess it didn't surprise you at all in the quarter, the amount of pricing pressure you have encountered?

Actually, you know, it has been pretty much like that for the last 2 to 3 quarters. You know, we had a lot of pricing pressure as we mentioned all the way along but I think it has been probably particularly cued in first quarter, fourth quarter, and continued in this quarter. So I would not say it is particularly worse in second quarter than it was in first quarter. Sometimes when we take deals in one quarter, we begin to supplement in another that impact of that revenue flow. So it depends on, some of this is going to move round a little bit depending on when we ship some of the deals that we get but in general, I will say pricing pressure has been pretty consistent across virtually all of our businesses for the last 9 months at least.

We go next to Fian from Prox . Please go ahead.

Hi, Good afternoon gentlemen. What was the main contributor to or contributors to the order decline in the general-purpose consistence?

Well, I think there is a couple of things there if you look at general purpose, it includes our manufacturing test business. We include, we break apart our automated test group into the semi conductor part which we break out and then the manufacturing which gets integrated into the whole general purpose instruments. So as we said before that business has been pretty tough down sequentially. Part of the issue there is, there is a lot of excess equipment out there in the gray market that our biggest competitor is ourself with used equipment or sometimes new equipment that is out there in the gray market. So that was probably the other, one of the biggest ones, then there is just, I think a couple of general-purpose categories, a lot of our general-purpose instrument categories were down. I think you could probably tie this to very similar phenomenon as communications. We don't break apart, you know, how many of those general purpose products go to Nortels and others of the world so some of this is a question of the particular customers and how much they are buying it. What we found in the past is these kind of downturn is people can't live with other quarter without power supplies or pulse generators or lot of these kind

of products with they tend to buy a lot of new stuff which they can't live without. So it is not unusual to see some of the general-purpose products hit during a downturn like this.

One other development is that a significant portion of these products, particularly in the manufacturing test go to major contract manufactures, the Selectrons and of the world and waste of lot of excess capacity and the biggest marketplace as far as they are serving the electronics markets which are still very soft. So this is sort of a second derivative impact of the downturn in the telecom market. The good news is that there are some signs of life among the first customers in we are indeed at the bottom and we will begin to come out of it in the second half.

We go next to Daniel of JP Morgan. Please go ahead.

Yes. Thank you. I just want to ask a little bit more on the gross margin but more perceptively than less perceptively. If we look at what is going on in the business, particularly a lot of new products coming on as of, I think next week. Ned said and I know that there is a pretty strong calendar behind that. Is it clear to assume you have some kind of a benefit with the gross margin as early as this quarter or is that get reflected in another quarter? I have just a clarification which is the source of the date on the market shares that largely differ from if you take market share across the board?

I think Adrian could comment on the gross margin.

Yeah, if your question is do we anticipate that we will see an improvement in our gross margin in the third quarter, the answer to that is yes.

And is it attributable to the fact that what you described is essentially mixed?

Not just mix; it is the continuation of the benefits from the restructuring program that we had under way for virtually a year now,continuing to gain momentum as we get cost and structuring complexity out of the system. Part of it is mixed but I also have to point out that sometimes that mix works on both ways.

Yeah, I know as of this quarter you just reported.

I think here the factors you mentioned like ceratinly the restructuring benefits we are moving forward and closing the fab in the pay areas and it gets completed at the end of this month. All of that get consolidated in few or more . We will see some benefits there. We have been working hard on consolidating other facts and outsourcing some of our lower level materials and of course the new product impact, I think we are still ramping along the new product that came out in the last 6 or 9 months, so they get to the point where they really do start having an impact on the gross margin by the second half. So I thunk it is really a combination of all of those factors.

In terms of market share data, it is a combiantion of things, Daniel, if you look at some of our business like semi conductor test, we can look at our data versus what our direct competitors do. people like and , we look at our numbers, you could also look at the LSI market share numbers and Dataquest and others, all of which have now come out for 2001and all of which have consistently shown that we have gained share.

And I think the same is true for number of the semi conductor product areas where we know we have; looking at some of the direct competitors we know we out performed these direct competitors. When you look at the different areas like OSS, some of our communication test products, here again, we look at how we do versus some of our larger competitors and can pretty well tell that that we are doing better than most. I didn't say that we are gaining in every area, but I did say that we are gaining or holding on our own in almost every area. I am not saying that there isn't one or two areas we may be even loosing a little bit but I think certainly across the board we are gaining and holding on our own in virtually all the areas. One of the things that just to remind you about it you haven't seen it, there was a recent RH case study that was done on the OSS market that clearly positions Agilent as the market leader, the number one supplier in network management software even ahead of companies like Hordy and Microviews and others. So again all of these data from third parties as well as looking at those vertical competitors that we can compare with to the extent that we have knowledge of their business, I think gives us pretty good indication that we are gaining share and again I don't want to say it is in every business but certainly by the large majority of business we are gaining or holding on our own.

We go next to Ned Rifen at Avon Research. Please go ahead.

Thank you. I was wondering specifically about pricing pressure in the side. As my pointed out regarding these pricing pressure and also about what you see for going forward? Thank you.

In terms of the pricing pressure, I know that some people are talking about pricing pressure in the fiber optic transceiver market but you have to remember where they are coming from. We have huge volume advantages. WE have been building fiber optic transceivers for the local area network markets now for a number of years as I mentioned. We have a 60 percent share of that market and we have only recently been focusing on the storage area network market where we are a lot of our economies and scales to that market. So I think, yes we have been pretty aggressive in pricing but we also have the cost structure that can support that.

In terms of your second question about the inventory level at Cisco, you know, I really can't comment on that. First of all I don't even know, secondly I probably shouldn't even comment on Cisco's inventory.

We go next to Reg Conosky at US Bancorp Piper Jaffray. Please go ahead.

Thank you very much. Couple of questions. First relative to order activity here in the July quarter. Is it safe to assume that given some of the stabilization we have seen in the core market plus the new products that orders, you expect orders to grow sequentially here?

We do expect orders to grow sequentially here.

Okay, good and also wanted to ask quickly about capital business. Is there anything to update us on in terms of outsourcing manufacturing, the sale of manufacturing assets and where do you might be in terms of percentage that is manufactured in house versus outside and how you can see that progress here for the next couple of years?

Let me give you a one statistic, we about 2 years in 2000 outsourced roughly 40 percent of our circuit assembly activity and did about 60 percent in-house. By the end of this year, we will be a virtually 100 percent outsourced on circuit assemblies. We have also consolidated down from, I think, around 20 or 30 different contract manufactures to five. So that is something we have done over the last 6 months or so.

In terms of final assembly and tests, we have outsourced some products for final assembly and tests but as I said before I don't expect that to be a majority of our business, probably will never get to be more than 20 percent or so of our total revenue, the reason being a lot of our products are very sophisticated, require a lot of tests and we think the test capability is one of the core competencies that we can bring to the party. So we do not expect to outsource all of our final assembly and tests but only on a subset of our total products.

Operator, we have time for one or two at the most for questions.

Yes Sir, thank you. We will take our final question from Steven Palayo of Morgan Stanley. Please go ahead Sir.

Great. Adrian, I am pleased you adjust for your 1 point gross margin , there is no labor cost there. You have got about a $31m increase in revenues and then about a $28m of adjusted increases gross profit. Where can I drop when we should think about going forward, kind of 90 percent level going forward?

I remember that we have got the third quarter coming up the year with the implementation of our ERP system and so it is going to be a little confusing, I suspect. That seems like it is a little aggressive going forward, but we have said pretty consistently that we are expecting in the 70 percent range.

Okay and then just remind me once again if you are looking at a break even in the fourth quarter, what kind of gross margin assumptions are you making?

We have never given that out.

Okay and then just one final if you take any more question here. Looks like the HP business, are the really driven in the past by the sub contractors mainly the traffics and businesses, you mentioned that, what type of the chips are they primarily for, the recent activity?

I think it is as we said before it is mostly in the consumer areas, it is also be seen on very good results on our flash memory test business. That did well both in first quarter as well as in second quarter. Again, it is more; I think the chip demand that we see is more in either enterprise or in the consumer space. I remember the thing that drives our semi conductor test business is really more on the high end, device design. The people want these kind of high performance type products. Today there is still lot of excess capacity out there for tests for some of the lower performance chip sets but people designed products in the point one three or point one five micron, the test capacity there is quite limited. That is where we get most of our designs.

I can't give you the names but I can give you an example of the variety of applications that is seen in the wireless tests. There is digital signal processors, web processing and mouse and , DVDs really it is a lot of variety, it is not just focused on one application.

That concludes the question and answer period today. At this time Mr.Terry, I will turn the conference back over to you for any additional or closing remarks.

Thanks, operator. That concludes our call. Again we thank you for joining us. We look forward to you speaking to you again when we report our third quarter results in August and as always if you have questions, don't hesitate to give us a call. Thanks for joining us today.

That concludes today's conference. Thank you for your participation and you may disconnect at this time.