安捷倫 (A) 2003 Q3 法說會逐字稿

Good day and welcome to the Agilent third quarter 2003 earnings conference call. This call is being recorded. At this time for opening remarks and introductions, I'd like to turn the call over to the Investors Relations Director, Mr. Hilliard Terry.

Thank you and welcome to Agilent's third quarter conference call. Before we begin, let me start by apologizing for the slight delay today. There was a delay with the wire service in getting the news release out, so we wanted to give you guys a little extra time to review the release, which should now be available on our website and all the other wire services and what have you.

With me today are Agilent's Chairman, President, and CEO, Ned Barnholt, and Executive Vice President and CFO, Adrian Dillon. After my introductory comments, Ned will give his perspective on the quarter and the current business environment, and then Adrian will provide more detailed commentary on the financials and the performance of each of our businesses. Then after Adrian's comments, we'll open up the call for your questions. Again, if you have not had a chance to review the release, you can find it on our website at www.investor.agilent.com.

In accordance with SEC regulation G, if during this conference call we use any non-GAAP financial measure, you'll find on the website the reconciliation to the most directly comparable GAAP financial measure.

Additionally, I would like to remind you that we may make forward-looking statements about the future financial performance of the company that 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 SEC to get a more complete picture of all the factors at work. The forward-looking statements, including guidance provided during the call today, are only valid as of this date. The company assumes no obligation to update such statements as we move through the quarter.

Lastly, we'll host a facility tour and product and strategy review of our life sciences and chemical analysis business in Wilmington, Delaware on Thursday, October 2nd. Also we'll have our annual New York City analyst day on Tuesday December 9th. Please mark your calendars for these events and take a look at our website for a complete list of upcoming investor events and conferences.

With that out of the way, I'll turn it over to Ned.

Thanks, Hilliard, and hello, everyone. Overall, we're very pleased with the Q3 progress in reducing cost and bringing the company closer to break even. Our operating loss of 2 cents per share is a significant improvement that positions us well for profitability in the current quarter. We're confident that we can build on this progress and reach an operating break-even cost structure of $1.45 billion in Q4, excluding about $45 million of investments in our ERP and customer support systems. This is the same goal we talked to you about at the end of last quarter and remain fully committed to achieving it.

In addition, we're encouraged by signs of modest improvement in some of the markets we serve. Our performance on cash flow was much improved and Adrian will provide more details. He'll also discuss the evaluation allowance on deferred tax assets.

With that as background, I'll briefly review orders and revenue. Total orders are just under $1.47 billion were up by about $12 million compared with a year ago but down about $60 million from the prior quarter. This order outcome is consistent with normal seasonal patterns for our third quarter.

There were several areas of strength in orders. Our automated test group achieved its highest order level since 2000, with especially strong sequential and year-over-year growth in flash memory test. In Q3 in semi-conductor tests, we booked a number of orders for multiple systems, an indication that some customers are buying for future capacity needs. We also had 161 design wins at semi-conductor tests this quarter, which brings our year-to-date total to about 380 design wins. We estimate that 220 of these are now in production.

In semi-conductor products orders for our embedded cameras posted strong sequential increase and there was good growth in networking ASICs. In tested measurements we strengthened our market share in oscilloscopes in part by very good acceptance of our recently introduced high-end product. In life sciences and chemical analysis, our business achieved modest order growth compared with Q2 and Q3 a year ago.

There was some uptick in purchases from pharmaceutical customers with the release of the National Institute of Health's budget of the United States driving spending by university and government researchers. In Asia, the ongoing infrastructure build out and a focus on food and environmental safety helped make that region our strongest area of growth for this business.

In Q3, we also introduced our time of flight product which strengthens our mass back offering. At $1.5 billion, total revenue grew by $111 million compared with a year ago, and by $35 million over the prior quarter. Our revenue was at the midpoint of the guidance we gave last quarter. Once again, our investments in new products helped our orders and revenues across the company.

We're very encouraged by progress on our cost structure. Total cost and expenses were lower by $130 million on a volume adjusted basis compared with Q2. This is excellent progress in implementing the plan we announced in February to reduce our quarterly operating break-even cost structure to $1.45 billion. All of our businesses and major functions did an excellent job on lowering cost.

A major factor in this result is the workforce reductions we have been implementing. During the quarter some 2400 people left the company. We expect to end the fiscal year with fewer than 29,000 employees. Some of these workforce reductions are related to the ongoing transformations and information technology, manufacturing, finance, human resources, and other key functions. In Q3, we made good progress in this area as well.

The rollout of our ERP system continued, and we moved forward in shutting down legacy systems and applications. We also continued to implement our customer support system, which went live in the first quarter. We are starting to achieve some of the benefits that we've been work towards in rolling out these systems, including lower cost, improved information sharing and more streamline processes. We made progress on our work to consolidate manufacturing into a smaller number of sites.

Another component of our transformation is selective outsourcing not just in manufacturing, but in IT and workplace services. Here, too, we executed well against our aggressive plan. So we are pleased with our results and progress in improving our cost structure. Our highest priority for the current quarter is to build on this momentum we have in getting to a normalized operating break-even cost structure of $1.45 billion.

I mentioned earlier we've been seeing some encouraging signs in a number of our markets. Here I would include semi-conductor tests, life sciences, aerospace defense, wireless handset tests, and parts of semi-conductor components. These are positive signs but substantial challenges remain. Visibility is quite limited, competition remains intense, and pricing pressures are not subsiding. The strength and timing of a more broadly based economic recovery are uncertain.

Despite these challenges, we remain committed to achieving profitability in the current quarter on an earnings before restructuring and amortization basis. We believe we can achieve revenue in Q4 between $1.5 and $1.6 billion. Our guidance for earnings is from an operating break-even to 10 cents per share.

I'm very pleased with how our people responded this quarter to the urgent need to return Agilent to profitability. Our results show that managers and teams across the company made tough decisions and moved quickly. I remain optimistic about our ability to reach and sustain profitability. We have the products, the customer relationships, the R&D engine, and the people that success requires, and we're determined to reach our goals.

Thanks again for joining us today. Now I'll turn it over to Adrian.

Thank you, Ned. Good afternoon, everyone. As Hilliard indicated, I'd like to provide some perspective on Agilent's overall financial results and review the performance of our business segments.

First, let me start with the $1.4 billion non-cash charge we took related to statement of financial accounting standards number 109, accounting for income taxes. As we indicated in the press release, we recorded this non-cash charge which essentially eliminates Agilent's net deferred tax assets in accordance with SFAS 109. This adjustment impacts both the GAAP tax expense and shareholders equity on our financial statements, but it has no impact whatsoever on the company's cash flow, liquidity or future prospects.

In large part because of Agilent's cumulative losses over the past three years in the U.S. and U.K., SFAS 109 requires that, "Greater weight be given to previous cumulative losses than the outlook for future profitability when determining whether deferred tax assets can be used." In essence, the company is now unable to reference forecasts of future operating profits to value its deferred tax assets for GAAP reporting purposes. Without being allowed to point to future profitability, the deferred tax assets have no value.

We want to emphasize that the writing off of our deferred tax assets was done strictly for purposes of conformance with GAAP, and does not in any way reflect reduced confidence in Agilent's future prospects. In fact, the company remains very confident it will be able to use the entirety of its deferred tax assets before expiration dates that range from 5 to 20 years. In effect, what this means is that until the company has achieved positive retained earnings, we will record a very low tax rate for GAAP reporting purposes.

After that point, the evaluation allowance will be reviewed periodically and could be reversed, partially or totally, on business results that have sufficiently referred to support recognition of the deferred tax assets for GAAP purposes. Until that time, we will continue to provide a pro forma presentation of Agilent's results with a normalized tax rate. That, for 2004, we expect will be about 31%.

Okay. Let's turn to financial highlights from operations. And let me remind you going in that the third quarter is normally a seasonally soft quarter. So the most relevant comparisons for most of our financial results are with last year rather than the prior quarter. In the quarter we had $1.47 billion of net orders that was up about 1% from a year ago, down about 4% sequentially again, given the normal seasonality of Agilent's results.

Revenue of $1.502 billion was right in the middle of our guidance range, up about 8% from the prior year. Remember, the last year we had implementation of our ERP system which did interrupt shipments a bit. Compared to the prior quarter, we were up about 2% sequentially.

Let's talk now about the impact of currency. Currency had no impact on Agilent's overall operating results because of our hedging strategy. The year to year impact of currency on our revenues and cost was about $30 million or about 2% of revenues. Sequentially, the impact was about $10 million or less than 1% of revenues. Looking at the gross margin, we achieved a 40.3% gross margin in the quarter, up 1.3 points from the prior quarter and up 3.5 points from last year.

The competitive environment remains really tough, but we did not see any further material deterioration in the level of discounts compared to recent quarters. In fact, in the gray market there were some tentative signs that the great overhang of test equipment is finally being worked off.

In operating expenses we had R&D spending of $225 million or 15% of revenues. That's down 22% from last year's $289 million or 21% of revenues. It was also down 16% just from the second quarter of this year. SG&A cost at $408 million were down 16% from last year and down 16% from last quarter, for about $78 million quarter to quarter, and as a percentage of revenues is now about 27%. Our total change in operating expenses were $121 million during the quarter compared to the prior quarter and nearly $140 million below last year at this time.

Now, we need to be careful about the seasonality of the business and cost. But the reduction in total structural costs, including costs of goods sold was $100 million quarter to quarter, even better than the $60 to $65 million improvement that we indicated we'd achieve when we discussed second quarter results. The pro forma tax rate was about 50%, same as prior quarter, and it will be the same in Q4, and as I've already indicated for 2004, you should be assuming about a 31% pro forma tax rate.

Okay. Let's do the reconciliation to GAAP results before turning to the balance sheet. We had an earnings before restructuring loss of $11 million or 2 cents per share, that's an improvement of 13 cents from the prior quarter and an improvement of 29 cents from one year ago.

During the quarter, we had $22 million of good will and intangibles amortization, we had $141 million of restructuring expense and taxes and other miscellaneous items of a plus $64 million. So had we not taken the tax evaluation charge, we would have reported a GAAP net loss of $110 million or 23 cents per share compared to a GAAP loss on the same basis of $223 million or 48 cents a share a year ago. Adding the $1.445 billion charge gets us to the total GAAP net loss for the quarter of 1.556b or $3.28 per share.

Turning to the balance sheet and looking first at the cash flow, as I mentioned earlier, we had a $110 million GAAP loss before the DTA charge. We had about $19 million positive working capital and other expenses for total cash used in operations of minus $91 million. That's fully $100 million better than last quarter and $90 million better than one year ago. Included in that $91 million of net cash used was $121 million of cash restructuring expenses.

If you just subtract that out, you would see that we were cash flow positive in the third quarter by $30 million compared to a $58 million cash consumption a quarter ago and cash consumption of $140 million last year at this time. So enormous improvement in getting to our operational break-even.

Good discipline was also continued to be demonstrated on Capex, which was at $62 million in the quarter compared to $77 million of depreciation. Our receivables have gone up in line with business, they averaged about 58 day sales outstanding consistent with the 57 days of last quarter or last year. But we continue to make great progress in our level of inventories. Inventories of $1.051 billion in the quarter was down $80 million from the prior quarter and was down a quarter billion dollars from last year at this time.

Days on hand at 106, days on hand has improved from 114 last quarter and 144 days a year ago. As Ned said, we ended the quarter at $1.43 billion of cash and equivalents on the balance sheet and we believe we have now gotten to the point of a cash flow break even.

Okay. Turning to the segments, first test and measurement, test and measurements orders of about $566 million during the quarter, off about 4% from last year. And in that 4% reduction, most of the weakness was in COM's test, which was down 9% year to year. Partially offset by a year-to-year improvement in general purpose test, up 8% from year to year.

Looking at orders and COM test, as we discussed last quarter excess capacity and supply issues continue in the Chinese mark. The impact of SARS on Chinese demand has dissipated we're beginning to see demand from some large equipment manufacturers outside of China as they try to build phone capacity ahead of the holiday season. So demand appears to be picking up there just a little bit.

The relatively strong performance of our wireless handset test business was offset as business continued weak in the wireless infrastructure area, really in the infrastructure area. The only opportunities are in the R&D space.

Our OSS business, however, grew from year to year and we did continued to capitalize on our current installed base by winning several new deals. While the OSS business continues to be lumpy given the long sales cycle, we believe OSS is the most likely area for increased spending as service providers look for ways to increase revenues and cut costs.

In general purpose, we saw strength in our aerospace and defense business, as Ned indicated, with higher government funding and resolution of the war reducing the uncertainty around test and measurement spending. So we did begin to see a pickup in demand there. We also continued to make in roads with our high end scope and probe with orders there growing 25% sequentially as we gained market share in that segment of the business.

For test and measurement, we had $613 million of revenues, up 18% from last year, when, remember, we did have the interruption related to the ERP. Our pro forma operating loss of $69 million really demonstrated the cumulative benefits of the aggressive restructuring that we've done in this business over the past year. Compared to the prior quarter, we had $34 million better performance on the bottom line, even though revenues were down $39 million, and especially looking year to year, we improved our profitability by $191 million on only $92 million higher revenues. We do expect that this biggest segment of Agilent will return to profitability in the fourth quarter of this year.

Turning to automated test, automated test had another good quarter with the highest quarterly order since 2000 and a return to profitability for the segment. Net orders were $251 million up 18% from a strong year ago period, up 15% from a strong second quarter. And for the first time in sometime, the strength in orders was pretty much across the board between semi-conductor test and electronic manufacturing test. STE was up 20% year to year and electrical manufacturing test was up 9%.

As we said earlier, and I think Ned emphasized it was a record quarter for flash test and the highest level of overall orders since 2000. In the first half of this year we continued to enhance our leadership position in semi-conductor tests as we installed the 550th 93K system and received an order for our 600th 93K system. SOC orders were down a little bit after a gang busters Q2 but we are still very strong and we continue our winning streak in delivering high speed test systems for applications like high speed wired COMs and testing high speed interface buses.

In electrical manufacturing test the visibility is still very limited. We're just beginning to see the early signs of an upturn. But we are encouraged by the fact orders are up a bit and we're finally seeing less competition from the gray market.

Revenues in the segment of $206 million were up 6% from a very strong last year and were up 35% sequentially. Our book to bill was $1.22 for the segment and 1.29 for semi-conductor tests alone, 10 bits better than the 1.19 for the industry. And during the quarter, we realized a $6 million operating profit. That's $43 million better than the prior quarter on only $53 million higher revenues, compared to last year we had $11 million higher profits on $12 million higher revenues. So again, demonstrating excellent operating performance.

Turning to semi-conductor products, we had net orders of $358 million, down about 7% year to year. Part of the reason for that decline in the year to year performance was because of the hard copy ASICs business that we've talked about on a couple of these earnings calls where we had very sharp increases in business last year at this time, and we've returned to more normal levels of business this year, but it does distort our numbers. If you took the hard copy ASICs out of our total orders, you would find that instead of our year-to-year orders being down 7%, that they would be up 7%.

One other impact on orders during the quarter was that several of our customers are rapidly moving to VMI, Vendor Managed Inventories. The initial affect of moving to a vendor managed inventory is you either cancel the inventories or you work those inventories down until you get them pulled from your supplier. Adjusting for about $20 million of the vendor managed inventories, we would have seen a 14% year-to-year increase in our orders, rather than the 7% decline that we recorded.

Within the segments, personal systems was the weakest, because it was the one that was hit most in the downturn of the hard copy ASICs and VMI. It was down 10% year to year at $240 million. Networking was ahead year to year by about 3% at $118 million. Within those segments we continued to see significant customer wins for our F bar, EPhempt and camera modules. However, these customer transitions to VMI did make it look like we had a temporary air pocket in orders during the quarter.

On the networking side, the overall enterprise market continues to show some signs of life as networking ASIC orders were up 6% sequentially driven by growth in networking ASICs. However, this was offset somewhat by soft demand in fiber optics and physical layer ICs. We think that the weakness in fiber optics was mainly the result of inventory corrections.

Revenue during the quarter was $380 million, down 3% from last year. Again, if you exclude the change in hard copy ASICs, our revenues were up 10% year to year right in line with the world-wide increase in semi-conductor shipments. The segment operating profits benefited from better yields on new products. The shutdown of our Newark facility and the restructuring actions we've taken, we had a net operating loss during the quarter of $8 million. That's improved by $35 million from the prior quarter on essentially the same volume and improved by $30 million from last year on $10 million less volume. So we are getting better yields and better results from the business.

Finally, turning to life sciences and chemical analysis, in the third quarter life science and chemical analysis orders and revenue showed some improvement from the generally flat trend of the past several quarters. Our orders of $293 million were up 8% year to year and 5% sequentially. Within that chemical analysis was about flat, up about 4% year to year. Strength was in life sciences where we saw a 14% year-to-year increase in orders and a 10% sequential increase.

In life sciences, there was a partial recovery in purchases from pharma, as Ned indicated as budgets began to loosen a bit. While the release of the NIH budget had a favorable affect on university and government research spending. As Ned also mentioned during the third quarter we introduced our time of flight mass spec product adding another key solution to our broad mass spec offering. And in chemical analysis, Asia was the area of strength for us.

Continued Asian infrastructure build out and focus on food and environmental safety helped chemical analysis, while the high oil prices continued to impact the level of margins and, therefore, the investment by the chemical companies.

During the quarter, revenues in life sciences was $303 million, up 6% year to year and 6% sequentially. Operating profits of $41 million were up $21 million sequentially and about flat with a year ago. This business, once again, demonstrated a return on invested capital during the quarter of 31%.

Finally, turning to guidance, Ned gave our fourth quarter guidance. We expect a normal seasonal increase in revenues, somewhere in the $1.5 to $1.6 billion range. And on that basis and on the basis of a 1.45 normalized operating break even, we would expect to generate a break even to 10 cents earnings per share in the fourth quarter.

With that I'll turn it back to Hilliard.

Thanks, Adrian. Operator, at this time, we're ready to take questions.

Thank you, today's question-and-answer session 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. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We'll take as many questions as time permits. Once again, please press star one on your touchtone telephone to ask a question.

Our first question today is from Deane Dray from Goldman Sachs. Please go ahead.

Adrian and Hilliard. Question on the restructuring plans for the fourth quarter. If you said it, I apologize. What do you expect to incur for restructuring costs and how much of that is cash?

Dean, we would expect to have around $30 million charge for restructuring recognized on the income statement and have something closer to $100 million of cash payments out the door during the quarter.

And in past quarters you've given an adjusted cash flow number, Adrian. Could you help reconcile where it worked out this quarter? You walked through the details and said it was $121 million this quarter?

Yes, that was the cash restructuring, Dean, 121. Let me give you the nuance again. If you looked at our GAAP loss, excluding the write-off for 109, it was minus $110 million. Then we had other networking capital another of cash generation of 19 million, which gets you to net cash use in operations of minus $91 million. Now, 121 of that 91 was cash restructuring, out the door. So if we were done with the program, we would instead have generated $30 million of positive cash from operations during the quarter.

Okay. So when you said last quarter you thought your burn rate would be anywhere between 50 and 100, you were just under the high end.

Yes, we ended up the quarter exactly where we expected to be.

Good. Just last question. What were overall cancellations in the quarter?

Not material.

Good. Thank you.

Our next question is from Arindam Basu from Morgan Stanley.

Hi. Can you hear me?

Yep.

Okay. Great. Adrian, you were talking about the hard copy ASIC sales. So sequential change in the spread sheets you sent out were revenues down 2%, [Inaudible] down 17%, personal systems, should we assume kind of commensurate issue, commensurate numbers in the hard copy ASICs?

Arindam, you're cutting in and out, but let me see if I can answer your question. I think your question was, was there any sequential difference in our orders for semi-conductor plus or minus hard copy, and the answer is no. They have followed the same overall pattern as the rest of our business from Q2 to Q3. The big delta is from the prior year when we were supplying ours and our competitors requirements and this year we've gone back to a normal position.

Okay. And did I get the 93K SOC wins as 161?

For the quarter, yes.

For the quarter, right. And then any sense of the 93K utilization rates in the wind? In production you gave a number of -- sorry, I can't find that number. Do you have 220 semi-test design wins in production now?

That's right.

Any sense of utilization rates there?

This is Ned. We had a total year to date design wins of 380, of which we believe 220 of those are already in production, 220 of those devices. We monitor utilization rates. In general, utilization rates are over 90%. In Taiwan it's actually about 95%.

Okay.

Another metric on that would be that those 220 that are in production are driving approximately 200 SOC systems.

Okay. And then one more thing. Could you repeat the depreciation number and then give a sense of inventory mix of raw materials versus with finished goods?

We don't provide the latter material. And the first question was?

Depreciation.

Depreciation, $77 million.

Okay. Thanks very much.

We'll go next to Richard Chu from SG Cowen.

Hi, good afternoon. Let me just try to understand a little bit more. The reported costs were unchanged on higher revenues. I assume that you had some fixed cost reduction. Can you talk a little bit about the incrementals in the business? And then second, on a forward basis, you said you would be at less than 29K, which sells a more aggressive cut. Where are the areas of incremental reduction, and do you expect to take the cost structure down further as you go into the new fiscal year?

Richard, this is Adrian. I'll start with this. The gross margin actually tracked the changes in volume pretty closely. In other words, yes, we did reduce some fixed costs in COGS, but in this particular quarter recognizing that it is a seasonally weak quarter, we basically tracked what happened to our volumes. In other words, we have watched very closely and seen that we have been forced at times to give back some percentage of those costs of goods savings to the marketplace, and I think we've been pretty clear about that. So this in fact did track reasonably closely to our expectations to date.

On the 29,000 head count, that is correct, we do expect to end the year at less than 29,000. That's based on announced plans we now have being fully implemented.

If I can ask for a clarification on your unusual IT spending of $45 million in Q4. Should we assume that number pretty much dissipates entirely as you enter Q1?

Richard, I would suggest that you get it go from 45 in Q4 to close to 0 in Q2 and interpolate along the way.

Okay, thank you.

Richard, before you leave, the 29,000, what we have talked about before is that we would be less than 30,000. Then when we made our announcement in February to take our cost structure from $1.6b to $1.45b, we thought we'd be somewhere less than 30,000. And what's happening is as we put our detail plans together, it now looks like that number is 29,000. So it's not really incremental; it's just further refinement of the plans that we announced in February.

Excluding IT changes, should we assume the cost structure goes down on a constant volume basis further in the new fiscal year?

Remember, when we talked about the $1.45 billion quarterly break even, we also mentioned that we expected that would go down another 50 million per quarter by somewhere around the middle of next year, based on the savings we would get from completing the ERP and CRM systems. So we expect there would be further reduction into '04.

Richard, this is Adrian, I understand what you were asking is, beyond that would we see any additional reductions in the first half of the year, and the answer is yes, there would be some modest further reductions over and above what we expect to get out from the IT systems in the first half of the year.

Okay. Thank you.

And we have a question from Edward White from Lehman Brothers.

Thanks, hi. I was wondering if you could talk a little about what you think about the sustainability of business in semi-conductor tests. Across the industry we've seen a lot of activity from subcontractors in Asia. But you've had a few quarters now where that's been getting stronger. How does that look going forward?

I would say, Ed, that it actually looks reasonably good for the next several quarters. I think what we're seeing is some increases in the consumer markets and some of the enterprise markets, which are driving underlying semi-conductor demand and with the utilization rates for testers being as high as they are, those translate fairly quickly into demand for testers. So I think if you look at most of the forecast, at least that we see, that, you know, that '04 should be a recovery year. We're already beginning to see it in the last quarter or two for us. And we think the outlook going forward for semi-conductor tests, at least for the next two or three quarters, as far as we can see, is still pretty strong.

Now, remember, flash memory business is pretty lumpy. Even the SOC business can be lumpy, when you start seeing multiple orders. So it may not be linear increase across every quarter. But again, I think the overall outlook for the next several quarters is pretty good.

Okay. Then secondly, on the wireless test outlook, how do you think that is now? I know a couple of quarters ago that had been a little bit weak, and then it seemed to have gotten better as we went through the last quarter. Looking forward, what are your thoughts on that?

Remember, last time we talked to you, we were still very concerned about SARS. There was a big overcapacity issue in China. And, frankly, the overcapacity issue still hasn't gone away. That affects mostly second and third tier players not as much as -- more than the big one-tier players.

So what we are seeing is a little bit of a strengthening in the wireless test as SARS abated as we went through Q3, we actually started seeing a little bit of improvement in the business later in the quarter, and we project that there will be some improvement going forward into Q4 and early next year. But I don't think it's going to be dramatically better until we get through this overhang of capacity that still exists in China.

Okay. And then finally on the order picture, normally the quarters that include the summer or weaker bookings quarters for the industry and then typically at the end of the calendar year you see a little bit of snapback, as you look at your own order picture, do you anticipate that you'll get some snapback and order activity?

Yes, Ed, we would expect to get the normal seasonal increase in our orders.

Okay.

Q4 is usually our strongest quarter seasonally. We certainly expect that. It's a combination of market factors, the end of the government fiscal year, the fact that, you know, Europe and other parts of the world return from vacations, holidays, and we start seeing more activity. But also it's because it's the end of our fiscal year, I'm sure our sales incentives kick in as well.

Okay. Great. Thank you.

And we'll go next to Jeed Pye [ph] from Thomas Weisel Partners.

Good afternoon, gentlemen. Congratulations. First, on some extremely impressive cost cutting.

Thank you.

Thank you.

Just two questions. One is about the wireless infrastructure test. Would it be possible to sort of give us a break down of what that is as in percentage of your wireless test and testing measurement and also whether you see the slowdowns that are proceeding over the next two or three quarters, do you expect that to pick up going forward?

Well, the infrastructure part is a relatively small part of our total wireless business. It was much bigger, obviously, in 2000. But right now there's just very, very limited investments in the infrastructure. Where we see most of the activity in the infrastructure side is more in R&D. It has a lot of the rollout of 3g and some of the other new networks are pushed out. So it's a very small part of the total. I don't have the exact numbers, but it's a relatively small part.

The second question is about when you look at your different geographic arenas, some of the order numbers and revenue numbers and compares that we look at don't give us a very good idea because you had the ERP hick up I think in mid-June of last year. Could you sort of give us some color as to what is happening, whether you see America strengthening or Europe weakening and in Asia Pacific what you are seeing in Japan?

Well, I think what we see is the Americas from a macroeconomic point of view, looking across all of our business and integrating together, I think you see the Americas improving somewhat. We had some very weak results in the early part of the year, partly impacted by the war in Iraq. We saw a lot of concerns about deflation and other concerns about the U.S. economy. But I think there seems to be a little bit more, I should say, cautious optimism among many of our customers, and we are seeing at least what we think is the beginning of a more positive environment in the Americas.

Europe has still been relatively constant for us. It's been up a little bit, if you look at the sequential increases, the year-to-year increases. But in general, Asia is the big region for us. There's no question it was impacted by SARS in Q2, and a little bit in Q3. And we expect to see that recovery in the remaining part of this year and into the future.

And what about Japan?

Jeed, this is Adrian. I would say there's a little bit of a surprise in the numbers we've seen in the last several months, it's the signs of life in Japan.

Okay.

Things do seem to be picking up a bit, particularly in semi-conductor tests and also some board test and even in our life sciences and chemical analysis, so some signs of life there.

Okay. And one last question is, Adrian you just mentioned a few minutes ago about currency not affecting things except to the tune of $30 million in revenues and $30 million in cost.

Correct.

Does that mean that earnings was not affected at all?

Correct.

So that 2% difference is both in top and bottom line. Going forward can you explain to us the cost of doing that, is it because of hedging or the natural hedge because of the cost of production and the way production is spread and the way your revenues are spread geographically.

Well, Jeed, we tried to very closely coordinate our natural cost, our natural hedges of orders and production in revenues and currency and invoice. So it's mostly natural hedges we've designed supplemented with just a little bit of currency hedging where appropriate.

And Malaysia is all dollar cost, right?

Correct.

Okay. Thank you so much.

We'll go next to Brett Hodess from Merrill Lynch.

Good afternoon. I wanted to first ask about the seasonal trend a little more, given the fourth quarter usually is quite strong from an order and revenue basis, the revenue outlook for flat is about up 6% was a little lower than we normally see seasonally. Is that still the affects of coming out of the first half issues that you just mentioned, or is it just a slower seasonal pattern than normal?

You know, these days it's a little tough to describe within a percentage point or two just what is the seasonality, especially in our business because we've had issues in the past with the ERP as well as the actual cycle that's going on. The hard copy ASICs last year as well distorted the data. So this is a conservative range, I guess I would say that. But it's what we also most likely expect. Leave it at that.

Let me just follow up. While there appears to be a more positive atmosphere amongst many of our customers, and I probably talked to 30 CEOs in the last six weeks, I would say most of them are still cautious about spending money. I think what we're seeing is people are feeling a little bit better, but I don't think it's realizing itself in terms of letting go of the purse strings yet. So we're being hopefully appropriately cautious about not being too excited about any turnaround. I'm not in any way declaring victory. I think we're still in very choppy waters, and the market is just too difficult to call.

Thank you. And quick follow on, when you talk, some of the comments made about strength in semi-test and pickup in life sciences from some of the spending trends that you talked about, sounds like some of the better margin areas are picking up perhaps a little bit more than the overall business. Is there any mixed benefit to margins that we might look for over the next few quarters?

No, I don't think you ought to assume that. Our test and measurement business also has very attractive gross margins. So I wouldn't expect there to be a true mix affect going forward.

Thank you.

And we have a question from Robert mere from Semi-conductor Equipment.

Hi. Can you tell us a little about the pricing environment in semi-test? Historically, you were one of the first to pickup in the market and then pricing action happened after that. Are you seeing any of that or are you being aggressive in pricing? Also, in terms of order patterns, obviously there's sort of early stage technology buying and capacity buying and everything in between, are we still at a point of onesey/twosey, or are we getting more customers ordering multiple systems? Maybe you can fill us in a little.

I think what we're seeing is a few customers ordering multiple systems, not lots of customers ordering multiple. It's still mostly onesey/twosey buys, but there are a few people that are starting to make some multiple unit buys. But, again, I wouldn't say it's across the board. In terms of the pricing environment, it's really not that much different than it's been in the last six months to a year. I think what we see is lots of -- you know, lots of people are all competing aggressively for the business that's out there, and clearly, using discounts and other things to try to win the business. We feel like we've been in a very strong product position.

Certainly we've been aggressive ourselves at making sure that we can win the business, but we've also walked away from business that we don't think that is good profitable business. That's not just in semi-tests but in all of our businesses, that if it looks like prices are getting such that this not good business for us to take, we're willing to sacrifice market share and top line to make sure that we get profitable business.

And we'll take a question from Terry Daniels from Edward Jones.

Hi, thank you. Can you hear me?

Yep.

Adrian, just a question from you, you obviously have done a lot with cost and help improving margins and so forth, and it looks like we're starting to see a pickup at least in some areas. What other sort of levers besides ERP do you have to improve utilization moving forward either through modular manufacturing of your products or some other changes there?

Well, I would argue that some of the benefits from the ERP and CRM are yet to come because we're just finishing the implementations there and the true benefits from re-engineering the processes and getting our customers and our suppliers on line are yet to come in a long-term context. But I would also say that much of the improvement you can see in our numbers now is a result of some real clamping down and focus on indirect spending. Not only are we manning the facilities correctly, not only are we moving and concentrating our production facilities, also selectively outsourcing, but we are really focusing hard on indirect level of spending. If you could see inside the books, that would be the area of most significant improvement just in the last three and six months.

Our next question is from Richard Eastman from Robert W. Baird.

Just two questions. As we go forward on the gross profit margin line. If we assume pricing is stable, we'll see some additional cost flow through there. But it sounds like most of the cost reductions here over the next few quarters are focused in on the SG&A and R&D line. Should we start building a gross margin number incrementally off of sales gains from this 40% level or do we, perhaps, see that slip back down a little bit? How stable is the gross margin line?

Rich, I would say that you can assume that you'll look at the volume based benefits in our gross margin plus some.

Okay.

Not minus some.

I think we're still seeing benefits just like in the ERP systems and some of the customer response management systems, we're still just beginning to realize some of the benefits of site consolidations. We just recently closed one of our manufacturing sites and semi-conductor products group. We begin to see those savings as we go into '04. So there's still benefits there, plus we think there's still lots of benefits as a result of ERP and some of these IT systems in doing a better job of managing our vendors, our inventories, all those things, that will all show up in improved gross margins. So we think there's still a lot of opportunity ahead, even without volume increases, but clearly we're depending on volume as well.

Okay. Then just secondly from a cost perspective, the R&D line dropped significantly. Again, how do you look at that line going forward? Will there be inflationary type increases in '04 or does that flat line out? How does R&D look going forward?

We expect we'll see R&D somewhere around the range of - 13% to 15% of revenue, clearly going forward. We expect to see a little bit of inflationary increase in wages and things. But also, in general, if you look at the total cost, you know, when we factor in allocated cost savings and other things, I think you're going to see it relatively flat.

Okay. Very good. Thank you.

And our next question is from Mehdi Hosseini from SoundView.

Yes, I have two questions. First, in regards to your semi-test. If you could clarify, you said you had a pocket of air in the semi-sensors and if you could just elaborate on how orders are coming different. Going back to your semi-test, you mentioned you had a pretty good quarter for flash testers. If you could elaborate on SOC tester and how it tracks on a sequential basis? Thank you.

Let me just say we did not say that we had had a pocket of air in semi-test. We had a very good quarter in semi-test. Overall semi-test was up 15% sequentially. We did say that a significant increase came in flash memory test. That was the major factor. But remember, last quarter semi-conductor test grew sequentially 117% over Q2 over Q1. So we continued to have a very high level of business in SOC test, but it didn't grow significantly above the level we had in Q1 or Q2, which was already significantly over Q1.

I apologize. My first question had more to do with semi-sensors in your semi group. In your prepared remarks, you mentioned slower than expected or hitting a pocket of air for semi-sensors. Did I just misunderstand you?

I think you may have misunderstood. We did mention that in the personal side of semi-conductor products that some of the weakness you can see, for example 10% weakness year to year, obviously had to do with the hard copy ASICs. But another part had to do with the move to vendor managed inventories, what we call VMI. And that had a one-time affect of making it appear like our orders suddenly softened because our customers are depleting their stocks and even canceling their orders as they then pull our products directly as we take over that process. That's a $20 million impact in the third quarter compared to the second or compared to a year ago that should not be repeated in the fourth quarter.

Great. Thank you.

Operator, we're approaching an hour mark, so if we could just take one more question.

Okay. That will be a follow up from Arindam Basu from Morgan Stanley.

Hi. One question on the SOC orders. I want to just get some clarification on the SOC orders being seasonality, and if you think the SOC orders will trend up again in October. I know you just made some comments on that. But Teradyne is guiding a modest increase in semi-test orders in September. So I just wanted to get a sense of your relative position relative to Teradyne given the different sequential trends you guys are talking about relative to them.

Remember, if you compare our results and Teradyne's, we actually saw the improvement before they did. We saw it in Q2, they saw a sequential improvement -- they saw their improvement in order levels in, you know, our Q3. So I think we certainly see the same things as Teradyne in terms of improvement in the business environment going forward, and we fully expect that we'll be able to maintain or grow share in the environment that's out there for SOC testers.

Okay. Thanks for clarifying that. And I wanted to get a sense of now that you've been talking about some improvement in the relative size of the gray market conditions becoming more benign, do you have a sense of the size of the gray market now, particularly in general purpose test?

Nothing we'd be willing to repeat.

I think if you look at the gray market, and we've mentioned in the past a few areas where it tends to peak up. One is in board test systems and what we have seen there is more and more of the used gray market test boards getting absorbed, where customers are actually starting to come back and look at new testers again. So that's a positive change. There's still plenty of gray market equipment out there in the optical area, some of the general purpose test areas, but I don't have a specific number on it. But we can just sense that at least in the board test area and parts of the general purpose test, you know, there is a reduced amount now compared to say six or nine months ago.

Okay. Got it. Thanks very much.

That does conclude our question-and-answer session. I'd like to turn the call back over to Mr. Terry for closing remarks.

Thank you all for joining us. We look forward to talking to you again on our conference call in November when we report our Q4 results. Thanks for joining us.

That does conclude today's conference call. We do appreciate your participation. You may now disconnect.