安捷倫 (A) 2004 Q3 法說會逐字稿

Good day, everyone, and welcome to the Agilent 3rd quarter 2004 financial results conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Mr. Hilliard Terry. Please go ahead, sir.

Thank you. And welcome to Agilent Technologies' 3rd quarter conference call. With me 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. Then Adrian will provide a detailed commentary on the financials and performance in each of our businesses. After Adrian's comments we'll open up the call for your questions. In case you have not had a chance to review the release, you can find it on our web site at www.investor.agilent.com.

And in accordance with SEC regulation G, if during the conference call we use any none GAAP financial measure, you'll find on our web site the required reconciliation to the most directly comparable GAAP financial measure. Additionally, I'd 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 of the factors at work. The forward-looking statements, including guidance, provided during this call today are only valid as of this date. The company assumes no obligation to update such statements as we move throughout the quarter. Additionally, we will host a investor event on Monday, August 23rd at our corporate headquarters in Palo Alto. This event will focus on our Test and Measurement business and provide attendees with an indepth understanding of our markets, product strategy, and the overall environment. Also we'll have product demos available. I encourage you to attend. With that, I'll turn it over to Ned.

Thank you, Hilliard and welcome everyone. We're very pleased with our 3rd quarter results. Overall, it was an excellent outcome for Agilent. We met our commitments, and achieved the high end of our guidance. Revenue of 1.89 billion dollars and operating earnings of 30 cents per share.

Our Test and Measurement business achieved operating profit of 11%. In May we said we were implementing actions to bring Test and Measurement to double digit operating profit by the 4th quarter of this year, and we made it one quarter early. Our expense control was excellent. Operating expenses were down $22 million, compared to the 2nd quarter. And order growth at 21% overall, was solid in all major geographies. Compared with the 3rd quarter last year, orders grew 28% in Asia, 26% in Europe, and a 11% in the Americas. While we're pleased with the sustained momentum in our Test and Measurement and Life Sciences and Chemical Analysis segments, our Semiconductor and Semiconductor Equipment businesses slowed somewhat from in the 3rd quarter. The order weakness in our systems on the chip business and Automated Tests was partly due to some overcapacity and lower demand at contract manufacturers. Making them especially cautious.

Our Semiconductor Product segment experienced a seasonal slowdown. A pattern that's accentuated as more of our business relates to consumers. We also experienced severe pricing -- pricing pressure, especially in camera modules. Even though our yields have improved, we were not able to bring our costs down enough to achieve our expected margins. Actions are now underway to restore operating margins in Semiconductor Products to double digits in the first half of fiscal 2005. Our results in Automated Tests and Semiconductor Products suggest that there was a pause in consumer electronic spending in the 3rd quarter. This pause has increased an already high level of global economic uncertainty, which has also been affected by mixed economic data, higher oil prices, fears of terrorism, and the normal uncertainties surrounding the presidential election in the United States. It's unrealistic to expect any economic recovery to proceed without a few bumps in the road. However, the strength in our Test and Measurement business in the 3rd quarter suggests that the overall industry recovery may be expanding into the networking and infrastructure markets, within communications. In a company as diversified as Agilent, different businesses face market and competitive conditions that vary widely. It's unlikely that everything will go perfectly each quarter.

And for Q3, we feel very good that we achieved our numbers at the high end of the range of our guidance. Our excellent results in Test and Measurement and Life Sciences and Chemical Analysis more than offset the slowdown in Semiconductors and Semiconductor Equipment. In terms of our guidance for the 4th quarter, it remains at revenues of 1.85 to 1.95 billion dollars, and operating earnings of 30 to 35 cents per share.

Let me close with a few comments on the significant progress we've made in the last year. Since the 2nd quarter of fiscal 2003, we have improved gross margins by five points, and reduced quarterly expenses by more than $100 million. We ended the quarter with $1.9 billion in the bank, an increase of one half billion dollars from this time last year. We accomplished these results by keeping our core R&D capability intact and introducing a steady flow of new products. We announced about 80 products in the 3rd quarter, including our Versa Test series V 5400 memory testers. The V 5400 delivers the lowest cost of tests for memory devices such as flash, D RAM and S RAM, and up to four times improvement over existing systems in throughput for wafer sort and final memory testing. The 3rd quarter is our fourth consecutive quarter of profitability. We remain committed to achieving our long-term operating model, and are making very good progress towards these goals. Thank you. Now I'll turn it over to Adrian.

Thank you, Ned. Good afternoon, everyone. Let me give you a few overall perspectives on the quarter for Agilent, review the performance of our business segments, and conclude with 4th quarter guidance. Overall, we believe it was a strong quarter for Agilent. Certainly the highlight was the return to double digit profitability of our Test and Measurement segment, which represents 40% of the Company, and which achieved double digit operating margins one quarter ahead of our commitments. Also notable was the discipline over operating expenses which dropped 22 million dollars from the 2nd quarter. Perhaps even more notable, operating expenses are up only $14 million from the 3rd quarter of last year. And that increase is entirely due to the impact of currency, that is in constant currency terms we've seen no increase in operating expenses over the pass year, despite a 24% increase in revenues over the same period. We also continued to demonstrate we can generate positive free cash flow from operations and tight control over the balance sheet. As the press release emphasized, we ended the quarter with $1.94 billion in cash, up $95 million from the 2nd quarter. Inventories days on hand hit a new record low of 91 days and in dollar terms inventories are up less than 1% from last year's 3rd quarter, despite the 24% increase in volume. Receivables DSOs also improved three days from last year to 55. Capital spending remained very low at $26 million, $39 million below the level of depreciation, as we continue to implement a more flexible, scalable outsourced manufacturing model.

So, turning to the overall numbers, net orders were $1.78 billion in the 3rd quarter, except for the 2nd quarter, that was the highest level of orders since the beginning of 2001. Up 21% from last year. As Ned mentioned, the order strength was broadly diversified with double-digit increases in all geographies. Revenues at $1.8 -- 9 billion were the highest since the 2nd quarter of fiscal '01, up 25% from last year and even up 3% sequentially during what's normally a seasonally soft quarter. The impact of currency was diminimous, about $28 million year to year, mean -- or 1% meaning that in constant currency our revenues were up 24%. When you look at Agilent's 3rd quarter performance compared to our secular business model, the only shortfall today is in gross margins where we remain below our 50% target. In fact, we have made considerable progress in most of the businesses, but that has been masked in the past two quarters by a deterioration in the Semiconductor and Semiconductor Test gross margins. Overall, our gross margins in the 3rd quarter of this year were 44.2%, up over 3.5 points from last year at this time, but down about half a point from the 2nd quarter. Looking below the -- the -- that top level, you would see that Test and Measurement margins have improved dramatically. This quarter they were above 52%, up over 10 points from last year, up 4 points just in the last quarter. In fact, if you you were to exclude Semiconductor Test and Semiconductor Products from our overall gross margins, what you would find would be that Agilent's gross margins today were at 51% at our long term target, up over seven points from last year at this time, up 3.5 points, just from the 2nd quarter.

Turning to operating expenses, you can see that we're performing at, or measurably better than our mid-cycle operating model. R&D spending at $230 million in the 3rd quarter of this year was up only $5 million from last year at this time, and down 7 million from the 2nd quarter, to only 12.2% of revenues, again, right on our target of 12-13%. SG&A costs at $420 million, up only 2% from last year, down $15 million from last quarter to 22% of revenues, well below the 25% or less mid cycle target for SG&A. Overall operating expenses at $650 million, up 14 million dollars from last year, or zero dollars in constant currencies, and down $22 million from last quarter. We believe this discipline over operating expenses demonstrates that the 2nd quarter was the aberration in a improving trend, but we realize that repeating this performance in the 4th quarter will be important to proving our point. Overall operating profits in the quarter were $183 million, that compares to a loss of $27 million last year at this time. And profits of $149 million in the 2nd quarter. Looking at taxes, our pro forma tax rate in the year-to-date is 28%. That's down 1% from our estimate as of the 2nd quarter. That adjustment down from 29 to 28% was worth about a penny to our third quarter results.

Reconciling now from operating earnings to GAAP earnings, we had non-GAAP net income of $154 million or 30 cents per share, compared to 24 cents per share in the 2nd quarter and a 2 cent loss one year ago. We had about $54 million in adjustments for goodwill and intangibles for restructuring, and for taxes and miscellaneous, giving a GAAP net income of $100 million, or 20 cents per diluted share. By the way, a reminder that beginning in the 3rd quarter of this year, we are treating our convertible debenture as if converted, adding about 36 million -- 36 million shares to the denominator and diluting our results by about a penny per share.

Turning to cash, a reminder that the 3rd quarter is always our seasonal low point for cash generation because of the timing of our compensation payments. We had gap income of $100 million. We consumed about $58 million in working capital. And of that $58 million, 56 was receivables on the higher volumes that we achieved during the quarter. For net cash generation of about $42 million. Subtracting out 26 million of cap ex, we had $16 million of free cash flow from operations. During the quarter we also had $32 million of cash restructuring costs, adding that back, and you'd see that we had about $48 million of free cash flow from operations normalized for the restructuring.

On the balance sheet, as I mentioned earlier, capital spending of about $26 million, depreciation of $65 million or 39 -- 9 million dollars cash generation there. Receivables at about $1.15 billion are up 56 million from the prior quarter. But that's based on higher volumes, looking in terms of DSOs, our days sales outstanding in the 3rd quarter this year were 55, three days better than last year at this time. And inventories at a billion 61 million, up only $10 million from last year at this time, or $11 million from the prior quarter. In terms of days on hand, a new record low of 91, 60 -- 16 days better than last year at this time. Cash balance, at the end of the quarter was $1.94 billion, up $95 million in the quarter, and up over one-half billion dollars in the last four quarters. In the 4th quarter, traditionally a good quarter for cash generation, we currently expect to generate more than $200 million of free cash flow.

Okay. Turning to segment information, first, Test and Measurement, net orders were $776 million. The best orders performance since the 2nd quarter of fiscal '01, up 37% from last year. For communications tests, about 70% of the segment, orders were up 44% from last year, and up 4% sequentially. General purpose test orders were about 30% of the segment, up 23% from last year, up 5% sequentially. Again, all geographies, and all businesses were up double digits from last year, including, for the first time in several years, wire line test. For some color on communications test, wireless continued to be the dominant driver of year to year growth led by our one box tester business, sequentially growth moderated as the equipment manufacturers began to digest the increased capacity they've put in place.

On the wireless R&D side we continue to see moderate growth driven by 2.5 and 3G technologies, coupled with R&D growth in China, as local manufacturers began to design their own cell phones. Wireless infrastructure also showed steady growth based on modest capacity expansion for existing formats to improve the quality of service, as well as the expansion of 3G capacity as it begins to ramp. And wire line test orders, although small, finally showed some growth as well. During the quarter, we saw more than 20% growth, both year to year and sequentially.

And in our OSS business, as Ned mentioned earlier, we had record orders and strong growth, both year-over-year and sequentially. For general purpose test, the market continued to show steady recovery, with the component and semiconductor markets leading the way, along with solid demand from aerospace defense. During the quarter, we saw the highest level of orders for our osiloscopes since the 4th quarter of 2000, and we saw the highest orders in three years for our logic analyzers, we are positioned well for the next large computer logic buying cycle which, to date, has not yet kicked in during this recovery. Revenues during the quarter were $768 million, the highest level since the 4th quarter of fiscal '01, up 25% from last year. Up 9% from last quarter. And operating profits, as Ned mentioned earlier, were very dramatically improved, $88 million, and 11.5% operating margin, that compares to a $69 million loss last year, and a $11 million of profits for a 2% operating margin in the last quarter. We achieved our commitment to double digit returns in the segment one quarter early, which obviously is gratifying. This fundamental improvement in margins is the result of the cumulative benefits of our aggressive restructuring program that is now virtually completed. A modest improvement in the systems and support businesses, and lower levels of discounts. Return on invested capital in this business is now at 14%, compared to 1% the 2nd quarter, and a negative 6% one year ago.

For Automated Test, it was a mixed quarter, with very mixed signals in the semiconductor equipment market, but excellent operating performance given the volatility of orders and revenues. Net orders in the quarter were about $208 million, down 17% year to year, and down about 27% from the 2nd quarter. Semiconductor test orders at about $159 million were off 26% year to year, and off a third from the -- from the 2nd quarter. Electrical manufacturing tests on the other hand, at $49 million continued to show good growth, up 36% from last year at this time, and up 7% sequentially. Revenues at $243 million were 18 million -- 18% above last year, but were down 9% sequentially.

Incidentally, our gross orders during the quarter were 248 million, but during the quarter several of our SOC customers pushed deliveries out beyond our six-month window for order recognition. So for financial purposes only, $40 million of orders were debooked. If we'd included those orders too, total segment orders were about flat with last year and down about 13% sequentially.

The 3rd quarter semiconductor test orders were mixed, showing sustained strong growth in our parametric test business and renewed momentum in our flash test business, but offset by weak performance in SOC. We believe weakness in the SOC business represents some cyclical lumpiness as the SCMs go through a digestion phase, as well as some nervousness by our customers about the overall strength of the market. For example, in this fiscal year, we've increased our installed base of 93 K SOC systems by more than 50% at our SCM customers, with demand not increasing at the same pace, utilization rates overall have dropped about 5 points at our SCMs in the last quarter, suggesting some digestion of excess capacity. In addition, as we continue to expand the capability of our single platform SOC strategy with improved price and performance, some customers are taking their time to evaluate these new capabilities, given the less urgent need for immediate capacity. In contrast, we've seen a jump in flash test orders compared to Q1, with the introduction of our new V 5400 memory test system. As Ned mentioned earlier, this system features the flexibility to test a mix of memory products including S RAM, D RAM and flash memory for high volume wafer sort and final test production environment. So far customer reaction has been very positive. And as I mentioned earlier, manufacturing test orders reached the highest points since the peak levels of fiscal '01, with strength in optical and X-ray imaging. Segment profits during the quarter were $19 million or 7.8% operating margin. Improved from a $6 million profit a year ago, though down from the $34 million profit in the 2nd quarter. Return on invested capital in the second segment was about 8%, versus 12% in the 2nd quarter, and 2% one year ago.

Turning to Semiconductor Products, Semiconductor Products had another strong top line performance in the 3rd quarter. Net orders of 470 million dollars were up 31% from last year, and down 10% sequentially. Personal systems, about 73% of the segment had orders of $343 million, up 43% from last year at this time, down 13% sequentially, while networking orders, about 27% of the segment, were up 8% year-over-year and off about 3% sequentially. Revenues at $539 million were up 42% from last year, and were up 2% from the prior quarter. In fact, revenues were the strongest since the 1st quarter of fiscal '01, with growth at least on par with the 40% growth of worldwide semiconductor shipments through June. The 10% decline in sequential orders reflects seasonal weakness particularly in personal systems products, as well as the supply demand tension that seems to have moved from shortage to balance, just in the last two to three months.

For personal systems orders, we continued to see strong demand for our F-bar filter, EPM power amp and our new integrated front end modules for the mobile phone market. We also received our first megapixel mobile camera phone orders for delivery beginning this quarter. Hard copy ASIC orders were down 3% year to year, but were up about 3% sequentially. We also won 2 high volume inkjet printer ASIC designs during the quarter. Incidentally, in last years -- excuse me, last quarter's conference call there was some question about our sales to HP. Today our total sales to HP represent less than 10% of semiconductor products revenues, and less than 3% of total Agilent revenues.

Optical mouse orders declined sequentially reflecting our large share in the highly seasonal nature of the PC mouse business. On the networking side, we have begun to see indications of increased corporate IT spending and capital spending for IP centric gear. Networking ASICS orders were down 3% year to year, but we saw a 21% sequential increase during the quarter. We also received strong orders for parallel optics for main frame computers and high capacity routers, and we secured design wins for our 4 gigabit tachion fiber channel controller solutions at 4 top tier storage system providers, with production shipments beginning in the 1st quarter of 2005.

During the quarter, the segment had profits of $33 million, or a 6.1% operating margin. That compares to a loss of 8 million a year ago, but is down $32 million from last quarter. Last quarter's margin was 12.3%. Return on invested capital, in the quarter, was 15%, obviously improved from the one -- negative 1% a year ago, but down from 26% in the prior quarter. During the quarter, we faced severe pricing pressures in mobile camera modules and fiber-optics that we were not able to overcome with generally improving yields. The business is actively engaged in getting costs out of these products, as well as transitioning to a new generation of camera modules with better pricing. This is hard work, in a fiercely competitive environment, but the team has committed to restoring operating margins to double digit levels by the first half of next year.

Finally, it's wonderfully repetitive to be able to say that it was another good quarter for Life Sciences and Chemical Analysis. We had some production issues that slowed orders and revenues for Life Sciences during the quarter, but overall both the top and bottom line performance of the segment was excellent. Net orders at $321 million were up 10% year to year, and down 5% sequentially. Chemical Analysis led the way again, $190 million of orders were up 13% year to year, Life Sciences at $131 million was up 5% from last year at this time. Revenue at $335 million was another all-time high, up 11% from last year, up 1% from the 2nd quarter during normally a seasonally weak period.

Orders for our Life Sciences products were down seasonally in the quarter, from a market perspective, global pharma spending continues to show steady growth, while generic drug manufacturers continue to drive demand in Asia. We had an issue in our gene array production that affected 3rd quarter orders and revenues and which has now been fixed. In fact, our whole gene array, is seeing strong adoption and has quickly become one of our most popular catalog products. Currently we are introducing the first whole genome array for Arabidopsis and for mouse.

In Chemical Analysis, food and water testing, chemical, and petroleum production continued to be the key drivers of year-over-year growth, especially in Asia. This quarter we also saw some orders for a few interesting uses for our products. For example, we are supplying the drug testing equipment for the Olympics in Athens. Also during the quarter, the NYPD ordered a number of our products, such as GSMS, LCs and data management systems as part of a crime lab update. This particular lab is responsible for the analysis of crime scene evidence, confiscated drugs, analysis of biological fluids for alcohol and drugs, and arson analysis. Those of you who watch "CSI" will have some idea what I'm talking about. Operating profits during the quarter were $46 million or a 13.7% operating margin, up from 41 million last year at this time and $39 million in the 2nd quarter. Return on invested capital in this business was an excellent 23%, 1% up from last year and 7 points better than the second quarter.

Finally, turning to guidance, Ned has covered the 4th quarter guidance. We will admit to being a bit manic depressive, given some of the cross currents we are seeing in our markets. Revenues of 1.85 to $1.95 billion and earnings per share of 30-35 cents, represents our best guess at this point in time. The guidance suggests a very modest 4th quarter seasonal rise in revenues and a sustained bottom line focus to conclude a really seminal yearly for the Company. At this point, let me turn it back to Hilliard.

Thanks, Adrian. At this time, operator, we are ready for questions.

Thank you. Today's question-and-answer session will be conducted electronically. To ask a question, please press the star key, followed by the digit one on your touch-tone telephone. Just a reminder, if you are on a speaker phone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, it's star 1 for questions. And we'll pause a moment to allow everyone an opportunity to signal. We'll go first to Edward White with Lehman Brothers.

Hi, a question on the semiconductor product side. You mentioned, you know, some of the pricing pressures in -- in a couple of areas, but you know there's a lot of talk about, you know, out of Taiwan about the potential weakness in CMOS sensor prices in the second half of the year. Can you talk about what you think the pricing outlook might be overall, as -- as you look out? Do you think that there's any sign that -- that may alleviate or how do you -- how do you see that at this stage?

Well, Ed, this is Ned. You know, I think, first of all, most of our -- most of our products are shipped under contract. So we have seen the prices come down over the last quarter. And clearly with more and more players in -- in the game these days, you know, the pricing competition has been pretty intense. We've made some assumptions about our ability to get costs down, commensurate with the prices coming down. That frankly have been difficult to realize. We -- we are working really hard to continue to get costs out. We're continuing to -- to try to redesign new products with -- with better margins. But I -- I think you can expect, going forward, this business to be relatively competitive, to stay competitive, and therefore we're going to have to be aggressive on an ongoing basis to continue to get the costs out.

Can you talk just for a little bit about your manufacturing strategy, and outsource strategy, and how that may help to play in the cost issue? In other words, you know, will the outsourcing help that? I know you've got some very cost-effective manufacturing internally that you are -- that you are using for semiconductor components, can you talk about how the manufacturing may play into that?

Yeah. We -- we have largely a outsource model already for camera modules. But we're continuing to look at how we can optimize that supply chain. You know, this business has grown so fast over the last year, that we really haven't been able to truly optimize the supply chain to make sure that we get the best overall costs. So we're working on that. We're looking at what we do inside versus outside. But in general, it's a very -- largely outsourced model already.

Okay. Great. Thank you.

Our next question comes from Deane Dray with Goldman Sachs.

Thank you. Good afternoon. I'd like to hear a bit more about how the margins in Test and Measurement were successfully brought up to 11%, you know, the quarter early. So if we roll the clock back to where we were last quarter, you talked a bit, you know, about what the pressures were. And in your prepared remarks, you gave three points, and if we could just step through those and perhaps quantify, so if the three were the benefits to restructuring, also address whether the ERP system was a factor there. The second is the support systems; was that the runoff of contracts, or, you know, what happened in that business, and how much did that contribute? And the last point about the lower discounts, is that -- is pricing getting any better, and what about forward discounts as well? Thank you.

Dean, this is Adrian, let me take a first shot at that. I -- I would say that the bulk of it was the restructuring activities. It really is the cumulative benefits of a lot of really hard work over the past 18 months, but especially in the past 6 to 9 months and the ERP systems completions and the increased visibility that we have over every aspect of our business has certainly helped that, to pinpoint where things are going well and where we need to focus our attention. There was a lot of systems and support business that we identified last time that hurt our margins, in fact, we think most of that bad business has now flushed through our business in the 3rd quarter, which is reason to believe that things could continue at least as strong, if not get better again, in the 4th quarter. And with respect to discounts, we saw a clear drop in the level of discounts in the quarter, and we expect that to continue at a equal pace in the 4th quarter.

The only thing I would add, Dean, on the discounts, we've talked about the gray market a lot. And, you know, think I at this point we've -- we've just seen a lot of that gray market competition go away. There's still some out there. But that's been a major, major factor in the lowering of the discounts.

And -- and what about, like, forward discounts? Is there -- is this -- are contracts that you are signing now reflect any issues there?

I think we can expect, you know, discounts to stay roughly in the -- in the neighborhood they are today. You know, it's a competitive market. We -- we believe that our discounts are -- are under good control. But, you know, it's -- it is -- it is a tough market. But I don't think you're going to see significant improvements from the levels we're at.

And if I can sneak a last question at -- question in, the word that wire line test is up is -- has to be good news. And what's driving that, please?

Well, I think it's -- it's two things. You know, as you know, we've been working real hard on our -- on our router test strategy, and we are beginning to get some traction there with some of our new products. We are also -- when we talk about wire line, we're also including some of our OSS or network management solutions that go into the wire line market. And, again, as -- as Adrian mentioned, we've had a really strong quarter for our network management solution. So it's primarily -- it's primarily in our -- in our router test area, and in network management systems.

Dean, one other thing I would mention too is that we are participating in voice over IP. And a number of companies have mentioned significant increases in capital spending to provision that capability, and we are benefiting from it.

Thank you.

We'll go next to Brett Hodess with Brett -- with Merrill Lynch.

Good afternoon. I was wondering if you could talk a little bit about wireless overall. A lot of your businesses are affected by wireless semiconductor, semi tests, popular TMO communications business, and if you could talk a little bit about, you know, maybe, you know, what percentage of your overall business is affected by wireless and maybe some of the different trends that you're seeing, some of the weakness relative to some of the handset related devices versus some of the strengths, and how you think wireless overall will affect you in the coming few quarters.

Well, first -- first of all, let me just comment, I think as -- as Adrian mentioned in his -- in his remarks, our communication test business is about 70% of test and measurement. And the wireless piece of that, when you look at -- when you look at orders and revenue, is somewhere between 80 and 85% of that. So clearly we have a big, you know, a big role in wireless. That includes, by the way, both our -- our -- all of the test equipment, the box equipment, that sells into R&D applications, it includes our one box testers for manufacturing, as well as our network management solutions. I think when you -- when you look at that -- that market, and of course then we also sell components into handsets, so we haven't broken out that number specifically. But, you know, I think when you -- when you look at all of our -- of our wireless business, across the Company, it's -- it's somewhere in the -- in the neighborhood of 25-30% of -- of our business. So, you know, what's the outlook going forward? We -- we see, you know, we see the real build -- rapid buildup in the last year, in capacity, in handset manufacturing. And as Adrian mentioned, that buildup is -- is moderating in growth rate. It's still positive. It's just not growing as fast as it was, say, a couple quarters ago. We're -- we also believe that there's a little bit of slowdown in purchasing components, because of some inventory accumulation. But, again, I don't think that's a big issue. And most people expect that -- that orders for wireless components will be resuming again this fall, during the back to school and Christmas, you know, season buildup. So overall, I think we're seeing -- we -- we believe wireless is going to continue to be a good business, a strong business for us for the remainder of the year, into '05. We're not seeing any signs of a downturn there. But we'll certainly see a moderation in growth rates from the levels that we've been.

Very good. Thank you.

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

Thank you very much. A couple of things. Could you touch on head count and whether it is -- it is declining at this point, what the outlook is there? And then related to that, as you look at the Test and Measurement business, Adrian you indicated gross margins were at 52%, it would seem to suggest huge leverage in the last quarter. How do you look at gross margin leverage in the Test and Measurement business from this point forward? And finally, Ned, when you talked about pricing pressure in camera modules, you had been talking 10, $15 handset content what does that look look right now?

Okay, Richard, I will start. Our head count ended at about at about 28,217 and so we've been -- that's actually a little bit below our 2nd quarter head count. And we are flattening, we expect to be flat, really for the rest of this year and into early '05. We are getting obviously outstanding productivity from our employees at this point, great leverage. And as you mentioned on the -- the Test and Measurement margins that have about -- gross margin at about 51%, there is still some leverage from here. We've said during, you know, the great times we ought to be getting into the mid-50s for that segment. And we are, you know, this is really our -- only our second really strong quarter for the business. Hopefully we're not even at the mid cycle point yet. And as we get more volume, we'll also get leverage on operating expenses as well.

Yeah. The only thing I would add is, you know, even though, you know, test and measurement is -- has -- has come back very well, and is at 11, 11.5% operating margin for the quarter, our -- our long-term commitment is still to 15% in that business. So clearly we have some additional room to expand our margins there. Regarding your question on camera modules, Richard, I don't have the specific numbers there. I think the camera module pricing certainly is coming down. I don't have the exact numbers, where they are today. There's also a rollover, as you know, as we go -- move into the megapixel cameras, we'll be -- will be higher in price but the VGA cameras in particular, I believe, are below the $10, but I don't have a specific number for you. We can get that for you, if you are interested.

Adrian, just to be clear on this head count and OpEx point, you -- obviously focused very heavily on that this quarter. Is there any sense at which the spending levels this quarter were unusual or should be viewed as transient, and as business normalizes in Q4, seasonally and forward basis that OpEx will begin to move up much more sharply?

Richard, I think what we hope to prove was that the 2nd quarter was the aberration, and I think with the benefit of hindsight, our 2nd quarter is often heavy on expenses and our third and our 4th quarters are usually under much better control. We -- we believe that this kind of discipline we will -- will continue into the 4th quarter, and you will not see a repeat of the -- what happened in the 2nd quarter.

The only -- the only comment, Richard, is, you know, it -- we certainly expect it will go up a little bit because, remember, in the summer months, you know, there's more vacations, so there's a little bit more time off. So I -- I don't -- I don't expect that we'll stay exactly at the levels we were in Q3. But we don't expect a significant increase from here.

Terrific. Thank you very much.

We'll go next to Paul Coster with JP Morgan.

Yes, a couple of quick questions, Adrian, first of all, you mentioned some restructuring expenses this quarter. Can you tell us what they were, and how they will yield results, and when?

Well, I think you began to see the results of it in the Test and Measurement this quarter. And will continue to in the future. A significant portion of that was related to the Test and Measurement restructuring, both systems business and some of the movement of facilities and -- and activity from the U.S. to Southeast Asia.

So it's almost immediate payback, you -- you think.

Oh, the payback is quite short.

Okay.

A lot of that -- a lot of that action was announced in -- actually, in April. And -- and the -- the actual, you know, people ended up leaving during the quarter, but the products were transferred in June, July. So that is basically done. Part of it also was a arty -- relatively artificial write-down of a cost of facility to market as part of the restructuring and was not really a cash cost.

Okay, and then two real quick questions on the camera modules, do you think you've lost any market share and clearly you feel that in going to new technology you can get back to reasonable margins. Can you just sort of give us a little bit of color on the latter, if possible?

Yeah. I -- I think it's -- fair to say that we've probably lost some market share on purpose. You know, again, as I mentioned, these -- there's a lot of competitors. There's very aggressive pricing, and if we don't think that we can make a good margin on the business, you know, we're going to -- we're going to walk away. We also think if -- as we move into some of the new -- newer modules, there is an opportunity for additional margins in the newer technology, the megapixel technology, for example, so I -- I think you -- you -- you can probably infer from -- from what we're doing here, is that we are certainly anxious to continue to grow this business, but we're not going to grow it at the sacrifice of our margins, we're going to make sure that the business that we take is good and profitable business.

Okay. Thank you.

We'll go next to Ajit Pai with Thomas Weisel Partners. Yes, good afternoon gentlemen and congratulations on a good quarter.

Thank you. A couple of quick questions, the first was about the [difidax] charge that you took in the quarter. So could you just explain to us whether, you know, now that your profitable, that -- would you be able to continue to make use of those non cash, you know the [difidax] assets that you have? And then the second question would pertain to your operating model for your automated test group and your semiconductor product group, both of which, I think you know, some industry analysts are predicting is going to have a downturn in 2005, and sort of give us some indication as to what the minimum operating margins in your new model would be for those two segments and what the break even point in terms of revenue would be for those two segments.

Ajit, this is Adrian. Let me take on the first one first. On [difertech] assets, that was a 1.5 billion charge we took last year at this time to take virtually a total valuation allowance that was required because of our cumulative losses. Now as we're making profits, on a GAAP basis it looks like we have a very low tax rate because we are, in essence, writing back on the deferred tax assets that we wrote off as we're able to recognize the profits, and let me remind you that depends on geography too. We have to make the profits in the same geography that we took the write off in order to be able to use those deferred tax assets. That was the reason that we were indicating that we would have a low tax rate for GAAP purposes, about 20% is our current estimate for the entire year because we are able to use a significant portion of those preferred tax assets. On the semiconductor products and semiconductor capital equipment business, as Ned emphasized earlier, we are largely a outsourced model. Particularly semiconductor test has done a super job of really flexing its -- being able to flex itself up and down the incrementals that it achieved just this quarter were really quite dramatic. Their ability to juggle in -- in volume environments that are changing quite dramatically, so we're not going to give you an exact break even or bottom operating margin because we'll get into a discussion of how bad could it be, but we think we've been able to achieve a significant flexibility and scaleability in these businesses.

Yeah. And looking at overall, Ajit, we've talked about our break-even point, our goal would be to be around the 1450 level based on the currency adjustments we've seen in the last year. Last year we had our -- we talked about a goal of 1400, but if you -- currency adjust that for today's currency rates, that would be 1450. We're a little bit higher than that now, mostly due to the gross margin issues that we talked about in -- in SPG and ATG, because of the volume. But, you know, we're -- we're confident that we can get and stick to those kind of break even levels for the overall Company. So if we can have a break even 1450 for the whole Company, while revenues are running at, you know, say 1.8, 1.9 billion, you see that we do have a fair amount of cushion there for a downturn, before we would drop below zero profitability.

Okay. And in terms of [difertech's] assets, could you give us some indication of what is remaining, that you've taken a charge against and you haven't taken a charge against.

Ajit, the vast majority of that $1.5 billion remains available to us and we'll be using up in the next three to five years, so we're going to demonstrate a low GAAP tax rate for a very long time to come.

Okay. Thank you so much and congratulations again.

Thank you.

We'll go next to Mark Fitzgerald with Banc of America Securities.

I'm a little curious on your kind of optimism about the re-acceleration in the chip business, and -- and the semiconductor capital equipment business, what's that based on at this point?

Well, first -- first of all, I think it's -- it's based on a seasonal effect, you know, if you just look at the, you know, the history of -- of the business, as demand increases in the -- in the fall for back to school, and Christmas holidays, you know, we'll be watching very closely the -- you know, the impact that has, both on our semiconductor component business, as well as on our test business. As Adrian mentioned, there -- we do believes there's some excess capacity out there in -- in the contract manufacturers. But just a little bit of uptick in demand, and we think that, you know, we're -- we're still in a position where we can see a upturn in our semiconductor test business. We're also seeing very good interest in -- in some of the -- the newer technologies, like our -- our memory tester, flash memory tester is a -- getting very well -- very good marks from customers, and then you have new technologies coming along like PCI Express, as you have you've heard PCI Express has been pushed out but, you know, sometime over the next three to six months, we think we'll start to see some demand ramping there. We're in a very good position to take advantage of that with our -- with our testers. So overall, you know, I think, you know, it's still yet to be seen how much upturn there is for -- for the Christmas season. I think that's the big variable. But seasonally, there -- there is a -- an impact in the consumer market for the Christmas upturn, and we'll have to see how that ripples back into the -- into the equipment side.

And if I could just, one quick follow-on, the availability of wafers from your wafer foundry suppliers at this point, are there any advantages that you are accruing as things loosen up?

We haven't seen anything immediately. I think, you know, there may be, depending on how things unfold, but at this point in time a lot of this -- a lot of this slowdown in -- in some of the end demand you're reading about, and some of the capacity excesses that you hear about from some of the other companies is -- is fairly new data, and it really hasn't rippled all the way through to pricing or availability of parts yet.

Thank you.

Operator, in the interests of time, we're going to take one more question.

Today's final question will come from Arindam Basu with Morgan Stanley.

Hi, gentlemen, a couple of quick questions on camera modules. Last quarter you talked about VGA yields, can you just talk about if there is any impact on profits of that -- in this quarter -- yield issues in this quarter. If you could isolate pricing, I guess, versus manufacturing efficiency, and then on the megapixel side, are you in volume on megapixel yet or is that coming next quarter?

Well, let me -- Arindam, let me comments on the yields first, our yields have come up very nicely. Last quarter we talked about our yields being low in our VGA cameras. Our yields are now up over 80%. We've made tremendous progress on our VGA camera yields. But the -- the problem is when you look at overall part costs, including the wafers -- the cost of the wafers we buy, the cost of the -- of the assembly and test of those wafers with our contractors, when you add up all of the piece part costs, assembly cost, test cost, wafer cost, we're still not where we expected to be. And certainly given the, you know, the way that pricing has unfolded here, that's put a lot of pressure on our margins, so it's not a yield issue. It's an overall piece part issue, and that's -- that's what we're working on, and with our overall manufacturing supply chain design, and working with our vendors to continue to drive down the costs of our piece parts. As far as megapixel, we are not yet in full volume production, as Adrian mentioned we have one won -- a -- a large deal for megapixel cameras which we will begin to ramp in the 4th quarter.

Thank you very much.

And, Mr. Terry, at this time I'd like to turn the call back to you for concluding remarks.

Thank you very much. We appreciate everyone joining us today. We look forward to those of you who are going to attend the Test and Measurement analyst day on the 23rd of this month. Thanks a lot.

This concludes today's conference call. We thank you for your participation and you may disconnect your phone line at this time.