安捷倫 (A) 2004 Q4 法說會逐字稿

Good day, everyone. Welcome to the Agilent Technologies fourth quarter fiscal year 2004 financial results conference call. This call is being recorded.

At this time, I will turn the call over to the Investor Relations Director, Mr. Hilliard Terry. Please go ahead, sir.

Thank you, Keith, and welcome to Agilent's fourth quarter conference call.

With me are 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 business environment, and Adrian will provide a detailed review of the financials and the performance of each of our businesses. After Adrian's comments, we will open the call up for your questions.

In case you haven't had a chance to review our press release, you can find it on our Web at www.investor.agilent.com.

In accordance with SEC regulations, if during this conference call we use any non-GAAP financial measure, you will find on our website the required reconciliation to the most directly comparable GAAP financial measure.

In addition, 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 to you look at the Company's most recent filings with the SEC to get a more complete picture of all the factors at work.

Forward-looking statements, including guidance provided during the call are valid only as of the date of this call, and the Company assumes no obligation to update such statements, as we move through the current quarter.

Finally, I would like to remind you that we will host our annual Analyst Day in New York, on Monday, December 13th. If you haven't already had a chance to do so, please feel free to register on our website, or contact a member of the investor relations team for further information.

With that, I will turn it over to Ned.

Thanks Hilliard, and welcome, everyone.

In Q4, we faced a tough environment in some of our key markets. We are pleased that we improved our gross margin, lowered expenses, and generated nearly $400 million in free cash flow. Despite the fact that revenue was $63 million lower than in Q3. In addition, several of our businesses had outstanding results.

We introduced a number of strong new products, and we made some significant adjustments to our business portfolio.

The issue for us this quarter was the weak environment in the semiconductor and semiconductor-related markets. This weakness had a significant impact on our semiconductor component and semiconductor test businesses, as well as on some parts of test and measurement. The pause in the growth cycle for semiconductors that we talked about in the Q3 call persisted, and our results and outlook are consistent with what many of our peers and competitors have reported.

While the slowdown this quarter happened a bit faster, and was more severe than we anticipated, we don't believe we are entering a downturn, that is all comparable to what we saw in 2001. There is clearly an imbalance in capacity and inventory that we expect will take about three to six months for the industry to work through. These adjustments will have a significant effect on our semiconductor product and automated test businesses for the next quarter or two.

Our view is that semiconductor component and test industries will still grow very modestly in FY '05, with gradual improvement as we move through the year. We're well positioned to manage through these sorts of ups and downs in our markets. The much leaner cost structure we have achieved over the last three years, enabled us to stay solidly profitable in Q4. It will also help us get through the difficult environment in the next one or two quarters.

Looking at our results by business, the standout was life sciences and chemical analysis. LSCA had an outstanding quarter with strong growth in its core chemical and pharma businesses, and a nice rebound in life sciences. We strengthened our offering in bio informatics this quarter, with the acquisition of Silicon Genetics.

Test and measurement also turned in a solid quarter with excellent profitability, thanks to strong shipments and very good expense controls. The OSF business turned business turned it's order growth of the last four quarters into a solid revenue increase in Q4.

We had very good quarter in our general purpose instruments, including oscilloscopes, logic analyzers and design software. Continued growth and measurement solutions for cellular handset R&D and infrastructure, was more than offset by a slowdown in orders from handset manufacturers.

In our automated test group, orders and revenue declined substantially from Q3, as semiconductor manufacturers slowed production and delayed capital spending. Customers also delayed purchases in anticipation of our recently released next generation flash memory and SOC test systems.

This quarter we entered the flat panel display test market, as we introduced an internally developed product platform and acquired IBM's flat panel test business.

Our semiconductor products group also had a difficult quarter. There is clearly excess inventory in a number of its markets, as well as intense pricing pressure.

In Q4, we announced plans to sell our camera module business to Flextronics. We expect this transaction to close by the end of the calendar year.

Our ability to weather a market slowdown is much greater than it was a few years ago. As you know, we have taken about $800 million out of our quarterly cost structure, and have increased the proportion of variable costs within that structure. The improvements we have made in manufacturing procurement, and our infrastructure systems, enable us to adapt more quickly and effectively to changes in our markets.

We're working to strike the right balance between short-term profitability and preserving the investments that are vital to our future. We will be very vigilant on expenses. We will focus on maximizing orders and we will emphasize delivery of compelling new products to the market.

This quarter, we continue to introduce a number of significant new products. In LSCA, we brought out new proteomic tools, and just introduced the industry's first fully automated lab on a chip system for basic research and drug discovery.

We are introducing important new products in our automated test business as well. Earlier this year, we brought out a new memory test system that broadens our available market. And we have significantly strengthened the 93,000 systems on a chip platform, with enhancements and new products. And introduced the 88,000 series to address the flat panel test market.

In test and measurement we introduced the world's first 13 gigahertz oscilloscope that will help drive our success in general purpose instruments.

So despite the uncertainties of the current environment, we remain confident in our ability to achieve our goals.

I would also point out that Q4's results were a good close to a very successful 2004 for Agilent. This was really our turn around year.

We achieved 15% order growth, and 19% revenue growth over 2003. Profitability was consistently strong. We generated more than $700 million in cash. We largely completed a major transformation in our operations, and we will continue to see the benefits of that effort going forward. We have maintained the R&D investments that are so critical to our future.

We are determined to build on these achievements, as we move through 2005. Looking ahead, we expect the difficult environment in the semiconductor and related industries to continue into the first half of 2005. This will clearly affect our semiconductor component and test businesses in the first one or two quarters.

There is also a high degree of uncertainty in the broader economic picture. For these reasons, we are taking a cautious approach to our guidance. For Q1, we expect revenue between 1.6 billion, and $1.7 billion, and operating earnings of $0.14 to $0.21 per share.

The challenges we face in our markets haven't dampened by optimism about Agilent's future. We are a stronger and more competitive Company than we were a year ago, and these strengths equip us not only to manage through turbulence, but to enhance our product and market leadership.

Thanks very much for being on the call today. I look forward to seeing you at our Analyst Day in New York.

Now, I will 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 some thoughts about fiscal '05 guidance.

Overall, we believe it was a mixed quarter for Agilent. We are pleased about how we managed what was within our control, quarter-to-quarter, despite $63 million lower revenues, we improved gross margins, reduced operating expenses, kept tight control over working and fixed capital, and generated $394 million of cash from operations. We're disappointed that our markets were even weaker than expected, especially in semiconductor related businesses, and we saw absolutely no seasonal fourth quarter pop in any of our businesses.

Turning to the overall numbers, we had net orders in the quarter of $1.6 billion, 8% below one year ago, and down 10% from the third quarter.

Geographically, orders were off about 10% in the Americas and in Asia, and about flat in Europe after adjusting for currency.

Revenue in the quarter was $1.82 billion, up 9% year-to-year, but down 3% sequentially. Currency had a minimal impact year-to-year, about 2%, or $25 million, and had virtually no impact quarter-to-quarter, and as usual, it had no bottom line impact on our results because of our hedging strategy.

For the full year, Agilent's orders rose 15% from 2003, to $7 billion, while revenues increased 19%, to $7.2 billion.

Our gross margin in the quarter was 44.8%, up .8 of 1 point one year ago. Gross margins improved .6 of 1 point from the third quarter, despite $63 million lower sales because of continued improvements in test and measurement, where gross margins improved 2 points and continued strength in LSCA, where margins improved 1 point from the third quarter.

These improvements more than offset a 2 point drop in semiconductor, and a nearly 5 point drop in ATG gross margins. For the year, gross margins averaged 45%, which is 4 points better than '03, but still 5 points away from our mid-cycle targets.

In operating expenses we continue to demonstrate tight control spending at or below our mid-cycle targets.

R&D, at $228 million, was down $2 million from the prior quarter, at 13% of revenues.

SG&A, at $415 million, was only 23% of revenues, down $5 million from the prior quarter.

For the full year, operating expenses fell $174 million from 2003, despite the 19% increase in revenues, as we realized the benefits of our multi-year transformation programs. Operating profit in the quarter was $173 million, or a 9.5% operating margin, up 2.2 points from a year ago, and essentially equal to the third quarter's 9.7% operating margin.

Taxes in the quarter, we had a true-up for year-to-date, a 26% tax rate from the previous assumption of 28%. That adjustment in our full year tax rate was worth $0.02 to our fourth quarter results.

You will notice that we made some progress throughout the year in bringing down our effective tax rate. At this point, based on the work we have completed to align our operations to customers and geographies, we believe that Agilent's 2005 pro forma tax rate will be around 24%, a rate that you can also use for longer-term forecasting.

On a GAAP basis, we expect a rate of about 20%.

Okay. That gets you pro forma net income of $153 million for the quarter, or $0,30 cents per share. Both of those virtually identical to the third quarter performance, and double the performance of one year ago.

Reconciling from operating earnings to GAAP, we had a $54 million of restructuring expense during the quarter, about half of which was associated with semiconductor products, about $24 million of taxes and other expense, to get to a GAAP net income of $74 million, or $0.15 per share, and that compares with $13 million, or $0.03 cents per share one year ago.

For the year, Agilent earned $529 million, or $1.05 per share on a pro forma basis compared to a loss of $121 million or $0.26 per share last year.

Perhaps the most notable aspect of our fourth quarter performance was in cash generation. We had GAAP net income of $74 million, but we also generated $348 million of cash from working capital and other, for $422 million of cash provided by operations, and subtracting out $28 million for CapEx, we had $394 million of free cash flow from operations.

CapEx in the quarter, as I said, was $28 million. For the year, CapEx was $118 million.

Depreciation in the quarter was $65 million, and for the year, $266 million.

By the way, for next year, you ought to assume roughly $260 million of depreciation, and about $160 million of CapEx.

We had an excellent performance in receivables. Receivables were actually down $106 million from the prior quarter, and down $42 million from the prior year to 52 days sales outstanding.

Inventories also had a very good performance -- 92 days of inventory on hand, 3 days better than last year.

As a result of all of this, we ended the quarter with $2.315 billion of cash on hand. That's an improvement of $378 million in the fourth quarter alone, and $708 million increase from last year at this time.

Okay. Turning to segment information, first looking at test and measurement. Orders in our test and measurement segment were $693 million, up 7% year-to-year, but down 11% sequentially. Overall demand in the test and measurement segment was driven by seasonally strong aerospace and defense business, but this was offset by slowing demand in wireless handset manufacturing.

Communications test orders were $460 million, up 3% year-to-year, but down 16% sequentially.

In wireless, we did see weakening demand for wireless handset tests, as NEMs put capacity in place earlier this year than last year, to avoid being late for the holiday buying season.

We have also seen a softening in the Korean market, especially with second tier suppliers, and we continue to see inventory pressures in the Chinese domestic market. We expect demand to continue to be soft through the first quarter, until we see more adoption of WCDMA hedge and other more advanced technologies.

While wireless handset test manufacturing orders were down, we saw nice growth in demand for our wireless handset R&D products, as customers begin to focus on new cellular formats 3.5g and converged cellular and winet devices.

Demand was also strong in wireless infrastructure test, as we saw some continued modest capacity expansion of base stations.

For wire line, wire line test orders were up 37% year-to-year and up 3% sequentially. We are finally off the bottom.

We're seeing some significant test opportunities in broadband access, voiceover IP, and fiber to the home. And as Ned mentioned, our OSS orders were down sequentially after an extremely strong third quarter, but were up 26% year-to-year. For general purpose, orders were $233 million, up 17% year-to-year, and up 2% sequentially. We didn't see the normal seasonality in most areas of general purpose tests, but demand driven by fiscal year-end spending at aerospace and defense, coupled with growth in logic analysis, scopes and design software. We expect to see continued strong demand from the U.S. government and prime military contractors, as recapitalization and modernization continues.

During the quarter we gained share on oscilloscopes, and we expect to continue to, with this quarter's introduction of a market leading 13 gigahertz scope.

We also saw double digit increase in logic analyzers, as high-speed serial buses continue to replace traditional parallel buses.

Revenues in test and measurement in the fourth quarter were $788 million, up 25% year-to-year, and 3% sequentially.

Operating profits at $116 million, were up 14.7% operating margin, compared to an $11 million loss last year, and an $88 million profit, or 11.5% operating margin one quarter ago.

Return on invested capital in this business today is 18%.

We're pleased with the continued financial progress of test and measurement, which is now only about 1point away from its mid-cycle operating margin target, and 3 points away from the ROIC target. We expect to hit those mid-cycle year targets in fiscal year '05.

Turning to automated test. Automated test had a difficult quarter, as business was much weaker than expected at a time that we are also experiencing major product transitions in several of our product lines. Net orders of $137 million in the quarter were the lowest since the first quarter of '03, down 47% year-to-year, down 1/3 sequentially.

STE orders of $107 million were down by 50% year-to-year, and a third from the prior quarter, while electrical manufacturing tests, at $30 million was down 27% year-to-year.

Fourth quarter orders did show some indications of stability in SOC test, as saw a slight bit of sequential growth, but this was offset by a sequential pullback in parametric test and a weak performance in our flash test business.

During the quarter, we removed $28 million of orders, because of push outs by our customers beyond our six-month recognition horizon. But none of those de-bookings were due to customer cancellations.

As Ned mentioned, we believe the first quarter will continue to be difficult. End market inventory levels continue to suggest a cautious environment, while utilization rates remain below the 95% level that is usually a trigger for accelerated buying.

On a positive note, utilization rates at our SCM customers did improve by 5 points during the quarter to 90%, despite the weak environment. And as Ned mentioned, we continue to extend the breadth of our offering as illustrated by the new product introductions 93k SOC platforms.

This quarter we secured a major RF production win against a very large competitor. We also announced a large purchase agreement with [indiscernible] a leader in RF mixed signal applications.

And despite very low flash memory orders this quarter, we also believe we gained significant market acceptance of our new V 5400 platform. And finally, as Ned also mentioned, we announced our entry into the flat panel test mark this quarter, with the introduction of our 8800 series and the acquisition of IBM's flat panel test business.

Revenue and ATG for the quarter was $196 million, down 25% year-to-year, down 19% sequentially. And in the quarter, the segment suffered a $7 million operating loss, compared to $45 million of profits last year at this time, and $19 million of profits last quarter.

Turning to semiconductor products, semiconductor had a weak fourth quarter with orders of $403 million, down 18% from last year, and down 14% sequentially to the lowest levels since early 2003.

We are suffering from the industrywide inventory backup, as well as losing some share in camera modules, optical mice, and fiber optics.

Personal systems orders were $287 million, down 12% year-to-year, down 16% sequentially.

FBAR filters and EP hemp orders were about flat versus last year, and down sequentially, as channels worked down inventories built up to meet fourth quarter demand.

On the positive side during the quarter, we did begin shipment of our first EP hemp based front-end modules to major customers.

Due to increasing pricing pressure and margin erosion we announced the exit from camera module business and the sale of associated assets to Flextronics. As Ned mentioned, we expect that transaction to close in December.

Optical mouse orders declined year-to-year and sequentially as customers took down inventories and built up over the course of this year.

We introduced our laser mouse during the quarter, showcased in the Logitec MX 1,000, and shows a 20 times improvement of tracking performance compared to an optical mouse.

On the networking side we saw orders of $116 million, down 31% year-to-year and down 9% sequentially. Networking ASIC orders were down about 6% year-to-year, but did see a 7% sequentially increase.

Demand for network storage products also increased from the previous quarter, although our largest customers transitioned to a VMI program which skewed the fourth quarter picture.

Finally, fiber optic orders declined 39% year-to-year, and were off 17% sequentially, with the largest impact being excess inventory of major customers.

We also continue to see severe pricing pressure, and have been hobbled by some production issues that have impacted our market share.

Revenue in the quarter was $486 million, up 5% year-to-year, but off 10% sequentially. Operating profits in the segment were $8 million for a 1.5% operating margin, compared to $40 million, or 8.5% operating margin last year, and $33 million or a 6% margin one quarter a ago.

Return on invested capital in the business, the 6% this quarter, down 9 points from three months ago.

Finally, life sciences and chemical analysis had another fine quarter. Orders, revenues, and operating profits all at record levels. Orders of $366 million were 10% above last year, with life sciences orders up 11%, and chemical analysis up 9%.

The production issues we had in our life sciences business in the third quarter have been completely resolved, and are no longer impacting orders or revenues. Revenues of $352 million were 10% above last year, and up 5% sequentially.

The life sciences products, we're seeing growth driven by our high productivity solutions that include our HPLCs and our integrated data systems.

Generic drug manufacturers, as well as global pharma companies, continue to drive demand for our life sciences products in Asia, and we're continuing to build our offering for proteomics and genomic solutions.

As Ned mentioned, during the quarter we completed the acquisition of Silicon Genetics, which increases our offering in bio informatics, with leading [indiscernible] expression and genetic analysis software.

Chemical analysis products, we saw good demand growth in the U.S. for our analytical products in forensics and in homeland defense. We're also seeing a replacement cycle for our large installed base of traditional LC and GC products in the U.S. and in Europe.

And finally, regulatory initiatives by Asian governments continue to fuel strong demand for environmental test equipment.

Turning last to guidance, Ned has covered our first quarter guidance of revenues of 1.6 to $1.7 billion in pro forma EPS of $0.14 to $0.21 cents per share.

We will give you our specific thoughts about the remainder of fiscal '05 at the Analyst Day meeting next month. Obviously, the outlook depends critically on what happens to our served markets over the coming year.

At this point, our best guess for those markets in '05 would be roughly as follows. For test and measurement, something like a 2 to 7% increase in year-over-year growth in '05. For semiconductor, probably flat for 2004, plus or minus 5%. For semiconductor capital equipment, we think it could be down roughly 10%. And finally, life sciences and chemical analysis markets, somewhere between an 8 to 12% increase again next year.

Again we'll have more to say on all of this next month, so at this point, let me turn it back over to Hilliard. Thanks, Adrian. At this time, we will take questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Deane Dray with Goldman Sachs. Please go ahead.

Thank you, good afternoon. First question is on your forecasting ability. If I'm not mistaken, the guidance that you gave for this fiscal fourth quarter was actually put out 2 quarters ago, so that's a market improvement in what the Agilent that we saw the past couple of years. So that's sort of precision, could you us through as to how you are better or where you have more precision in your forecasting, and then related to that, your confidence on the semiconductor test side that you think you might see weakness for only 3 to 6 months?

Deane, that feels like a setup to me. This is Adrian. I appreciate the compliment.

Hopefully, the quality of our forecasting has improved; although, again, admittedly we did not get it exactly right. Our market did soften more than we thought and quicker than we thought in the fourth quarter. The fundamental is, you either decide that this is a -- a new downturn and it's a really a no growth market, or you look at the underlying data and see that electronics and consumer electronics worldwide are not declining. In fact, even the rate of growth is slowing only modestly. What we had was a position of about 2 years of shortage, turn into a significant surplus over a period of about 3 to 6 months. And we're now dealing with the implications of that inventory bulge much more rapidly than has traditionally been the case in these high-tech industries. So it feels painful.

It feels like a downturn, but hopefully, unless the underlying demand for consumer electronics and enterprise demand softens suddenly, we think we will have worked through the inventory goals within the next 3 to 6 months. Then the underlying production will catch back up to continuing demand. And again, we saw just a little bit of evidence of that in the pick-up and utilization rates of our SOC testers in Asia, which despite the slowdown in semiconductor production, improved by 5 points. But let's be honest, this is a forecast at this point and we hopefully will look back in 6 months and see that we were right.

But we do know, Deane that particularly the semiconductor test business is very volatile and very difficult to predict. And it -- as I said, the downturn in Q4 was much sharper than we had anticipated.

The good news, though, is, you know, I think the utilization rates are stabilizing. They are around 90% for the contract manufacturers, particularly in the -- in Asia, and we're coming in to this next year with a really fresh lineup of products. So the flash memory tester that we introduced in the third quarter started shipping in the fourth quarter and we're now beginning to expand to a number of new customers. And this introduction -- recent introduction of our new SOC platform is very significant, and it's a significant enhancement to our cost performance, and we think it's going to serve us well as we go into this coming year. So we feel good about our product position. We feel -- we feel that these inventory issues and capacity issues will get corrected, but it's really difficult to call when that's going to occur at this point.

And then just a second question on cash flow, I think the guidance was for free cash flow of about $200 million. It came in almost 2x that, which raises a higher quality problem of your growing cash position and what might be. If you could rank your potential uses of cash.

Let me -- let me tell you that what I've said before is, you know, we are very much going to sit on it, and make sure that we have sufficient cash for whatever we think might come along. If -- if this does turn out to be a downturn, and, you know, the market environment does weaken significantly for next year, we want to make sure we have plenty of cash. So that's the first thing.

But once we get to that point where we're comfortable, and frankly, you know, I think we're getting close. We probably will feel more comfortable with a little bit more right now but we're getting close to where we're comfortable. Then we'll look at things like, you know, stock buybacks, buying down or convert some cash acquisitions. We've already made 2 cash acquisitions this quarter, the flat panel display business and Silicon Genetics.

So, you know, we're spending a little bit for cash, but then on top of that, you know, we will look at some of these other possibilities as well. But at this point in time, it's -- it's really too early to call exactly how much or when we would do that.

We'll go next to Richard Chu with SG Cowan. Please go ahead.

Yes, hi. Good afternoon. I'm wondering if you could talk a little bit more about the guidance for 'Q1. First of all, what assumptions do you make with respect to the divestiture of the camera business. How much of an impact will that be. Is it $20, 30 million. Is it included in your guidance or excluded.

It is included in our guidance, Richard. We expect to continue to have the business through most of December, and so consider it roughly half a quarter's worth of business adding $300 million per-year level. It is a business that has been unprofitable and so it is getting less unprofitable, but it really will have a fairly deminimous impact in the first quarter but we should a positive impact in the second quarter.

Does your guidance envision generally any further changes in your fixed cost structure, your operating structure, are you making any adjustments to your operating cost structure?

We -- you know, we did announce some restructuring in our SPG business about a month ago, as you know, we -- we've had a fab in fort Collins that has been building CMOS image sensors for us. As that business has shifted more to chartered TSMC and others, that fab was clearly under utilized. So we announced some restructuring there, and so we -- we have seen some -- some -- we will be seeing some benefits from that.

But, you know, we expect over time that we'll continue to realize some benefits from our IT systems, and some of the other investments we have made, but I don't think those are going to be major impacts, more just continuous improvement going forward.

So put alternatively, do you see any meaningful shift in your breakeven levels between Q4 and the quarter just ended and the first half operations?

You know, if you look at our break even levels we're currently running just a little bit below $1.5 billion a quarter. And a lot of that is driven by gross margin issues. I think if you look at camera modules, it's clearly one of the -- one of the challenges, and the divestiture of camera modules will actually bring down our break even point, both in SPG as well as Agilent overall.

Similarly, we are addressing some issues in our fiber optic business as that business has seen a significant downturn in business this year, so we're addressing some of the cost structure issues there. And if you look at some of the other businesses, like ATG, we have also seen some gross margin reduction there but a lot of that is volume related. So I think as we see our volumes pick up here from the low point, we should see the -- the break even come down.

And if you can bear with me for one more question. You alluded to the slowing in communications wire line had, manufacturing testing. Is there any way that you can quantify the degree of slowing of reduction and run rates that you have you seen. You've seen very strong growth over the last two or three years and I wonder how much of the shift of level we are looking at.

Are you talking about wireless handsets?

Wireless handset manufacturing.

Testing. Yes, basically what we have seen is a number of large customers have pushed out a fair amount of business, and if you look at it for Q4, we estimate it might be in the range of $50 million of business that we expected to get in Q4, which got pushed out either into Q1 or Q2. And this is largely because people felt they had sufficient capacity to meet the needs of their Christmas buildup, and were not needing to add additional production lines. So that's -- you know, I think that's something that, you know, we didn't see how quickly that was going to come. We heard that there was going to be some slowdown in Q3, but it -- but it actually happened probably to a larger extent than we expected in Q4.

Does your guidance envision that there is a further substantial deterioration in those run rates, or are you assuming it stabilizes it at these weak levels?

You're talking about in handsets?

Yes.

We are expecting that we will continue to see a relatively flat to slight up turn in that business in Q1. And then probably beginning to accelerate a little bit more in Q2. Again, usually after the Christmas holidays there's a little bit of a period of people figuring out what to do next, so we don't expect we'll see a lot of business in January of the -- you know of our first quarter, but clearly by Q2, we expect at that point people will be rebuilding and restocking inventories.

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

Yes, Adrian, you know, obviously you made a lot of progress with cost containment over the last year or so, however, as we look forward into the next quarter, revenues are essentially -- they look like they will be about level with the same time last year. And earnings will also be about the same level. So it feels like we sort of come a long way and yet, we haven't come very far. Why is it that we're not seeing an improvement year-over-year in view of all the operating expense reductions that you have done.

Paul, I would say that we have seen very significant change again, $174 million year-to-year reduction in operating expenses alone. Now, really the reason for the apparently poor incremental year-to-year, as Ned said earlier, has to do almost exclusively with gross margins particularly in our semiconductor and semiconductor test businesses where they are down 10 to 12 points from one year ago, because of the very weak conditions in those businesses. Beneath that, you would see very attractive incrementals in the test and measurement and LSCA businesses.

Well, thank you for sort of correcting me there. And the second thing is on the handset side, we know that the handset business is still pretty interesting and there seems to be a lot of growth in camera cell phones on a year-over-year basis, and yet the sense of business is proving to be unattractive to you. How do we reconcile those -- those differences?

You're talking about the sensor business or the test --

Well, camera cell phones, obviously, still remain a buoyant growth market and yet, you know, it's not a market you choose to be in, at least the sensor subset of that. What is going on there?

Well, you know, this is the market that changed very dramatically in the earlier part of this year. You know, for the first two years, we were in the business. We were essentially on allocation, and so was everybody else. We couldn't ship enough units fast enough. And then all of a sudden, more and more people entered the business, and that -- you know at that point in time, caught the ASPs started to plummet.

And as quickly as we were able to take costs out, we were not quick enough, and so, you know, we're -- our goal, when we look at our businesses, you know, we would like to be able to make 12, 15% operating margins on our businesses, and it was very clear that this was going to be a business that would be challenged to make anywhere near those kind of margins. So we -- you know we decided that we would divest the module business.

Now, remember there's a difference between the modules and the sensors. We still build the silicon piece. We kept our image capture and image sensor technology. What we sold was the actual -- was the actual module, the integration of the silicon with the lenses and everything else. And, frankly, companies like Flextronics are probably better at that kind of manufacturing than we are.

Got it. And then last question, Adrian, if I can go back to gross margins again. In the next quarter where do you think gross margins will come in the aggregate level?

We don't give quarter by quarter guidance on gross margins.

Okay. Thanks very much. Appreciate it.

We'll go next to Stephen Kofler with Wachovia Securities.

Good afternoon. A couple of questions. Adrian, I'm sure you don't want to go deeper into the, you know, into the sketch of '05 that you gave, but just on the fly, sort of not being able to calculate each line item. It would seem that based on what you said in comparing it to your various assumptions, you would -- am I correct in thinking that the Company's revenues would be getting back above $1.8 billion pretty quickly?

Well that does depend on the shape of the recovery, so I wouldn't want to -- to bet on that by a particular, you know, first -- we obviously don't think it will happen in the first quarter.

Yes.

Or necessarily the second, but you take those year-to-year growth rates and yeah, I by the second half of the year that's your getting to.

It would seem -- I mean I haven't been able to really work it through but even higher, something closer to 1.9 billion would have to be in the cards if you were looking at the kind of growth rates you were talking about. Well, if you do the weighted average growth of those markets that I gave and you don't get a very big growth rate next year for all of Agilent. But, again, to be clear what we are currently saying is that this is a sharp adjustment, not a fundamental downturn and if we are right and the inventories do get cleared in the next 3 to 6 months then we will return to our prior trajectory in the second half of the year. Okay and basically when, you know, looking at gross margin, if you return to these levels of, you know, something a little above 1.8 billion, we should assume that you could achieve the same kind of gross margins that you had at those levels, right? There's no reason they should be lower.

Absolutely.

We expect them to be higher.

Yes. We are in the process of fixing semiconductor and semiconductor tests so we would be very disappointed if we only got back to where we are today.

Understood. Last quick question on history here. I think I was told book-to-bill in ATG was .7. Is that correct?

I think so.

Can you think back over the last, I don't know, 5, 6 years what the lowest book-to-bill you've seen in that area?

Oh, it's been lower than that. This is a business that unfortunately is extremely volatile. So you can go back to the -- certainly all of '01 and even parts of '02 and '03, where we saw the same kind of volatility in book-to-bill.

But I mean, what's the lowest you have seen? .4? .5?

I don't have the that number off the top of my head. I can get back to you with that.

Okay. Thanks.

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

Thank you. Adrian, if you look at your option expense, they run $0.12, $0.15 a quarter here. Is there any reason that's high at this point, and will it come down going forward?

Well, the truth is, we are not, obviously recording option expense in our pro forma so you are talking about footnote information, and we're still doing the calculations based on sort of the standard Black-Scholes, very high 70% volatility. All of this, we think extremely overstates the actual value of the options for a company like Agilent. But we have not gone through the lattice model or variations on that yet. If you compare the experience of other companies, what you will find is that there's usually about a 40% hair cut between the lattice valuations and the Black-Scholes valuations. So in the absence of any other information, that would be what I would guide you.

Okay. And is there -- as we get closer to this being adopted into new accounting standards, is there any change in philosophy in the Company on the use of options.

Well, we have, over the last several years continued to bring down our option dilution rate. You know when we were first starting as a Company, we -- we had an unusual situation where people, you know, didn't automatically convert their HP options, so the first year we had something like 6% dilution, second year was about 4.5, because we were in this tech boom where people were, you know, all trying to raid each other's employees. So since then we have come down over the last 3 years, and then we went to 3%, and then it was 2.5, and this year, it's actually probably going to be even a little below 2.5. So we're continuing to bring the dilution rate down.

I think the other thing to remember about our options, the -- the -- I will get on my soap box here a little bit, but the crazy thing about writing off and expensing options is that virtually all of our options are under water. I think we have most -- there's maybe one option we gave in the last 2 years ago that's in the money, but virtually all of our options are under water, even though we have to write down, you know, a significant expense.

Okay. Thank you.

We'll go next to John Harmon with Needham & Company. Please go ahead.

Hi, good afternoon. I have a couple of questions for you. Talking about your fiber optic business, you said there was pricing pressure. I was wondering if it's still coming from Chinese start-ups. And secondly, what is the effect of the recent consolidation [inaudible - microphone inaccessible] on pricing in that business.

Well, at this point in time, you know, there are a lot of new entrants. There are Chinese entrants, Taiwanese entrants, so we're clearing seeing price pressure there. I would say, yes, excuse me, that we've really seen a big impact from these acquisitions because they are relatively recent. Other than to say that it's -- it is just always been a -- or certainly in the last couple of years, a highly competitive market.

You know, have you a number of large customers, and, of course, everybody wants to win a significant share of those customers. So it tends to lead to relatively aggressive pricing and I wouldn't say it's change as JDS acquired EDO and -- and the Finisar made their acquisitions, but it's definitely a very competitive market. I think the real threat longer term continues to be the low cost entrants from Asia.

Okay. Thank you. And you mentioned you had a production issue. Is that on an existing or a new product and has it been fixed?

It has been fixed. We had some -- we had some quality issues, actually, a dimensional problem issue that was about 2 or 3 years old, that was just recently found that we -- that we had to go back and fix, which put a hole in our production. We were -- we had to stop shipments until we could fix that problem. This quarter, it probably impacted orders in the range -- or orders and revenue in the 10 to 20% range -- or $10 to 20 million range.

Okay. Thank you. I was wondering if you could give us some kind of idea, say looking into Q2, for your semiconductor business, the question is about your components for handsets. If everything stays flat and you -- you close the sale of your camera module business, what kind of a benefit to operating margins could we see in Q2?

Well, you know, our wireless components that we sell into handsets are -- are very volume dependent. You know, so we -- we have this relatively high fixed cost investment we made in our FR filter manufacturing capability in Colorado -- in Fort Collins and then also our EP power module facility also in Fort Collins. So we have a relatively fixed investment so the margins are very dependent on volume and what we saw this quarter was that people had actually bought their volumes early in anticipation of the Christmas season, and we actually saw relatively flat business actually down slightly in our -- in some of our wireless components. So you have a high fixed cost and you have flat or down volume, your margins, obviously, suffer.

We expect after the Christmas holidays, again, probably after January, as we go into Q2, that there will be reordering that we expect that we will see that business ramp further in '05.

We have also won a significant number of new platforms, just recently, particularly in our power amplifier business, and entering the GSM, the wide band CDMA is ramping. And one of the things that's getting a lot of interest from customers is the fact that we're integrating our FR filter and power amplifiers into front-end modules and, you know, we are ramping as we speak our front-end module capability. So we expect that over the next, you know -- next 4 to 6 months we'll be ramping capability there, or ramping our volume.

We'll take our next question could from Brett Otis with Merrill Lynch. Please go ahead.

Good afternoon. A couple of questions I had on the semiconductor side. You noted that there was some share losses in the camera-related and optical mouse series and what not. Are those pretty much losses just because of competitive pricing that you have walked away from, or is there something changing in terms of, you know competitive offerings?

No, I think you -- it's a little bit different in each case. You know if you look at the -- the optical mouse, you know, there it really is the entrance of a number of new competitors, primarily from Asia. Here we are taking very aggressive stands to protect our intellectual property. So as you know, we filed suit against Pixart and we are being very aggressive in trying to protect our intellectual property but in the meantime, that -- you know, these folks are coming in with very low prices and we have seen our business erode, particularly in places like China, Taiwan, and others in the U.S. We are actually -- we're actually been able to hold on relatively well.

I think in terms of -- in terms of the camera module, again, as I said earlier, it's the fact that so many people have entered the market, prices are just coming down dramatically and it's frankly, a case right now there's probably too many people in the camera module business.

Fiber optics is actually a whole different story. That's primarily our own execution. You know, we're late with a couple new products. We had some quality issues, as I mentioned, and we're working very, very hard to fix those as quickly as we can.

The second question on the semiconductor equipment side of the business, semiconductor test, a lot of the comparable companies in the industry have been talking about trying to make a much more significant move to outsourcing modules and what not to lower cost regions and, you know, reducing manufacturing cycle times, et cetera. How far along is Agilent with their semiconductor test products? Do you have a lot of room to continue to take cost down there, using similar types of strategies.

Actually, we've -- we're way down that path. We have completely outsourced already our board tests, our flash memory test. We have outsourced virtually all of the subassemblies of our NSOC testers. So there's very, very, little actual in-house manufacturing that we do. So we are very, very far down that path. We've been working on that for the last 3 years.

This is Adrian. I would provide a metric for you and say the rest of the industry is trying to catch up to where we are. During times like this, it's not to our advantage, but we can take an order and have a delivery and acceptance of a delivery in 3 weeks, and nobody else can come close to that. So we respond very quickly to upturns in the market. We also get whacked first in the downturn in the market. But we have been able to provide a scalability and a flexibility that we think is the furtherest along in the industry.

Operator, in an effort to keep this call to an hour, we are going to take two more questions.

Okay. Our next question will be from Edward White with Lehman Brothers. Please go ahead.

Hi. I was wondering, can you bring us up to date on how far along you are with your strategy to increase share in the general purpose test and measurement market. You talked about a pickup of share in the oscilloscopes, and where do you think the next steps will be there?

Well, we introduced a whole New Line of logic analyzers earlier in the year. We're getting very, very good takeup, as Adrian mentioned. We had strong double digit growth this quarter in that area. We just introduced our 13 gigahertz scope at the end of the quarter, so it really didn't have a big impact in Q4, but we expect going into '05, that certainly we're going to be in a -- in a strong position.

But we've also rounded out a number of our other products. We have come up with with a number of new general purpose instrument products, that are, I think -- have a lot of potential and are doing well. But, again, it's still very early. One of our other initiatives in test and measurement, which affects both general purpose, as well as our RF and microwave business. This last quarter, we announced a whole new line of what we called synthetic instruments, which address aerospace defense requirements, and this is based on the industry standard, or at least we're trying to create an industry standard around something called LXI, LAN-based instruments. And we're getting a lot of interest from other test manufacturers there. So I think we have a lot of momentum in our general purpose tests and it's -- we expect that going into '05, we should do quite well.

Secondly, if we look out to the next, you know, quarter, or say generally the next few quarters, that the operating margin profile -- you know, one thing about this quarter was that even with the revenue declines in some areas, you didn't have a division, you know where you had large operating loss. You know, which -- which was different from what we might have seen in the past, and I -- you know, as we go forward, you know, do you anticipate that you will continue to have most of the operating income generated by test and measurement and life science chemical analysis, you know, while -- while the revenues and profitability might get a little bit worse in semiconductor test. As you look at it right now, is that the profile you see or do you see some weakness in areas that are currently strong? The test and measurement and life cycle chemical analysis?

No, that's really the model that we have been working here for sometime. You know, you look at our Company. Somewhere around 60 to 65% of the Company is in the test and measurement and life cycle chemical analysis business. Those are really good solid, strong businesses, and particularly now that we have test and measurement back, you know, closer to where we want it to be, around 15% operating margins, LSCA at 16% operating margins, these are two good solid, strong businesses. And then -- businesses and the way we see it is, you know we'll have a ripple on top of that, based on the semiconductor cycles that will affect both of our automated test and our semiconductor component business.

But the good news is that if we have a solid foundation, a solid base of good businesses, around which you will see some of these cycles. So in a downturn, you know, we -- we should, barring some big, you know, economic recession, you know, if you see operations like we're in today, we actually have kind of a floor on our -- on our -- on our profits, which -- which are a result of the low point in the semiconductor cycle, and then certainly we expect there would be some times when we'll do a lot better on the up cycle. So this will be -- this will be a nice, good, solid position for us going forward to have these two businesses in strong positions.

Ladies and gentlemen, we'll take our last question from Ajit Pai with Thomas Weisle Partners.

Good evening. A couple of quick questions. The first is about the wireless exposure. Wireless handsets, as a percentage of your overall revenues, could you give us some idea of what it is and then how much of that is to one vendor and then is to tier two and below.

AJit, we have somewhere between 30 and 35% of the companies tied directly to -- directly or indirectly to wireless handsets, mostly in tests, but also in semiconductor, and it is almost by definition all of the [indiscernible - microphone inaccessible] because we test somewhere between 70 and 80% of all of the handsets on a worldwide basis. The semiconductor is much more focused on the tier one and Asian tier one supply -- or handset manufacturers. And if you look at just what the communications test part of test and measurement, which -- which is the largest part of test and measurement, roughly 75 to 80% of that is -- is wireless. Now, wireless included R&D. It included infrastructure. It includes manufacturing. So -- but clearly, in the test, communication test, a big portion of it is wireless and probably close to half of that, 40 to 50% of that is -- is manufacturing related.

Okay. And then looking at the same, you know, communications test side of things, on the wireline side, you are hearing about wire line spending, carriers finally after two and a half years beginning to spend over there. Is that something you are seeing as well?

Well, as we said for a number of years, the -- or a number of quarters, I mean, the wire line people are spending money. They are spending it on installing, rolling out IP networks. The voiceover IP really is getting traction. There's certainly some spending going on in the access markets. Even in some of the metro markets. So even though the overall wireless spending is relatively flat to down, or wire line spending is flat to down, there is some activity in these areas, and those are the areas that we have been focusing on with our router testers, with some of our protocol testers, some of our -- you know, some of our hand held installation and maintenance products, very much focused around the areas of the wire line market that we think there will be some activity.

Ladies and gentlemen, this does conclude today's question-and-answer session. At this time, I would like to turn the conference back to Mr. Terry for any additional closing remarks.

Thank you for joining us. We look forward to you joining us in New York on December 13th for our analyst meeting. Until then, thanks a lot.

Ladies and gentlemen, this does conclude today's teleconference. We appreciate your participation and you may disconnect your phone lines at this time.