安捷倫 (A) 2005 Q1 法說會逐字稿

Good day, everyone and welcome to the Agilent Technologies first quarter's conference call. This call is being recorded. At this time for opening remarks, I'd like to turn the call over to the Investor Relations Director, Mr. Hilliard Terry. Please go ahead, sir.

Thank you and welcome to Agilent's first quarter conference call. With me are Chairman, President and CEO, Ned Barnholt; Executive Vice President and CFO, Adrian Dillon; and Bill Sullivan, Executive Vice President and Chief Operating Officer, and Agilent's incoming CEO. After my introductory comments, Ned will give his perspective on the quarter and a few additional thoughts. Then Bill will say a few words followed by Adrian's review of the financials and the performance of each of our businesses. After Adrian's comments we will open the call to take 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 Regulation G, 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 of financial performance of the Company that involve risks and uncertainties. These risks and uncertainties could cause Agilent's results to differ materially from management's current expectations. We encourage you to look at the Company's most recent filings with the SEC to get a more complete picture of all the factors at work. The forward-looking statements, including guidance provided during today's call, are valid only as of the date of this call. The Company assumes no obligation to update such statements as we move through the current quarter. With that, I'll turn it over to Ned.

Thanks, Hilliard, and hello, everyone. I'm pleased with our results in Q1, especially given the challenging environment in several of our key markets. We showed very good operating discipline on a number of fronts and we benefited from the improved cost structure that we have in place. Our earnings were at the high end of guidance. Our gross margins improved compared with the fourth quarter, and we kept operating expenses under good control. We also generated about $100 million in free cash flow. As in Q4, a key factor in our results was the weakness in the semiconductor-related markets and in wireless handset manufacturing test. This weakness affected our top line significantly. Total orders were flat compared with Q4, and revenue was lower by $164 million.

We did see some encouraging signs in our semiconductor products business and we believe that the semiconductor and related markets are working through the inventory and capacity issues that had been well documented. We continue to believe that the climate in the semiconductor industry will improve gradually as we move through the year. In Life Sciences and Chemical Analysis there was growing demand for our test solutions as large pharma companies seek to increase their productivity. There was also strength in the chemical, food safety, and environmental testing markets. Revenue in LSCA increased 13 percent compared with a year ago and the business achieved an operating margin of 14 percent and an ROIC of 29 percent.

In semiconductor products, despite the overall softness in the market, we achieved good sequential improvement in orders, gross margin, and operating profits; thanks in part to operational improvements in our camera module and fiber optics business. Revenue from camera modules as well as optocouplers and navigation components also helped drive the improved results. As you know, we completed the sale of our camera module business to Flextronics earlier this month.

The inventory and capacity issues I mentioned affected our automated test business significantly in Q1. In SOC tests we achieved our second consecutive quarter of sequential order growth, but there's still excess overall capacity in the industry and the demand picture has a lot of uncertainty. Overall, we believe the market may have bottomed but is still soft compared with 2004. We are encouraged by our results in parametric test and flash memory and our new flat panel display business is off to a strong start. In Test and Measurement, our overall results compared with Q1 last year showed good improvement; driven by the benefits of the restructuring we have done over the past three years. We also had excellent market response to our recently-introduced high-end oscilloscopes. However, the continued demand from the handset manufacturing test market in Asia had a significant impact on Test and Measurement from Q1. Adrian will provide further detail on our financial results in a few minutes.

But as you know, this is my last quarterly earnings call that I'll be on as CEO, and I'd like to make a few additional comments. Many of you heard me say that there were two criteria I had for when I would step down as CEO. I wanted Agilent to be in good shape, and I wanted to identify at least one strong internal candidate who is ready to become CEO. I believe we have met both criteria. I have tremendous confidence not only in the Company's future, but in Bill's leadership. Bill has a great track record as Agilent's COO in leading the comeback of our test and measurement business. I'm delighted that the board selected him as the next CEO.

As I prepare to step down, I want to thank the people on the call and your colleagues for your support of Agilent over the past six years. I have learned a lot and have benefited enormously from my interaction with the investment community. These six years have been an incredible ride for us. We launched the Company, achieved strong growth, navigated the downturn and transformed virtually every aspect of how we operate. The Company is well positioned to extend the market and technology leadership we have and Bill is the right person to lead Agilent in its next phase.

In addition to our products, technologies, and market position, there's another Agilent strength I would encourage you to keep in mind. As I've discussed with you a number of times, our goal has to bring -- has been to bring all four of our businesses to best-in-class performance levels and to sustain their performance at that level. Our breadth and technology, sustained leadership in many markets and range of customers we serve sets Agilent apart from almost all other companies. I'm confident that the investment community will increasingly recognize and reward Agilent's market and technology breadth, which is part of what makes us the premiere measurement company in the world. Thanks again for your support and your interest in Agilent over these past six years. Now I'll ask Bill to say a few words.

Thanks, Ned. It's a great honor for me to be Agilent's incoming President and CEO and I want to thank Ned for his tremendous leadership over the last six years. Agilent is a very sound company and we have a lot of strengths.

There are a few points I'd like to make today. First, Ned and I are committed to a smooth transition and it is going very well. In short-term, Agilent will stay focused on the priorities and plans we have in place and on meeting the financial commitments we have made. In addition, there will not be any change in our drive to achieve the long-term operational model we have discussed with you. Operating margins at 14 percent and a return on invested capital of 21 percent-- business cycle. Just as we have always done at Agilent, we will continue to assess our business portfolio and make adjustments that will help us achieve our goals. I'm fully committed to working with our management team and the board of directors to maximize shareholder value and I'm excited about our potential to do that. I'm also looking forward to working with all of you in my new role. Thanks. At this point, I'd like to turn it over to Adrian.

Thank you, Bill, and good afternoon, everyone. Let me give you a few overall perspectives on the quarter for Agilent, a view of the performance of our business segments and then conclude with some thoughts on second quarter guidance. Overall, the quarter was pretty much on our expectations, and fairly straight-forward from an operating perspective. Semiconductor-related markets were weak as expected, while Life Sciences and Chemical Analysis markets showed sustained strength. We are pleased about our operating performance, given the topline with gross margins flat or higher than prior quarters and operating expenses under pretty good control. Our working capital ratios continue to improve, and as a result, we were cash flow positive again this quarter, generating $100 million in free cash flow and ending the quarter with nearly $2.5 billion in cash on hand.

Turning to the overall numbers, net orders in the first quarter were $1.61 billion, down 7 percent year-to-year and just about flat with where we were in the fourth quarter. As in the fourth quarter, orders were off about 10 percent year-to-year in the Americas and in Asia and about flat in Europe, after adjusting for currency. Revenues in the quarter were $1.66 billion, up about 1 percent year-to-year and down 9 percent sequentially. Currency was worth about $32 million year-to-year, so we were down on a constant dollar basis about 1 percent. Gross margins of 45.7 percent were about flat with last year, but differed greatly below the surface. Test and Measurement margins up 4 points, but Semiconductor margins down 5 points and Automated Test Margins off more than 15, due to weak volumes and competitive pressures. Compared to the fourth quarter, margins were up almost a point, despite $164 million lower revenues because of a nearly 6-point improvement in Semiconductor margins. We began to put some of the operating issues surrounding camera modules and fiber optics behind us.

For operating expenses, we experienced a slight year-to-year increase in real terms while quarter-to-quarter, spending was flat once adjusted for currency movement. Because we did not take first quarter spending down as fast as revenues dropped, operating expenses did bump just above our mid-cycle operating targets. R&D, at $231 million in the quarter, was up $12 million, or about 5.5 percent, and that was split about 50 percent currency and 50 percent real increase. Compared to the prior quarter, R&D was up $3 million, or down $1 million in currency-adjusted terms. SG&A costs of $420 million were up $20 million from last year, or about 5 percent; and, again, about $10 million of that was currency, about $10 million of it was real. Sequentially, we were up 1.2 points, or $5 million, or down $2 million, adjusting for currency. That leaves us with operating profits of $106 million, or 6.4 percent, of revenues. That's down $31 million, or 2 points, from last year at this time.

After $26 million of other income and a 24 percent tax rate, our pro forma net income was $100 million, or $0.20 per share, just about equal to last year's $103 million, or $0.21per share. During the quarter we had about $3 million of intangibles write-off, about $9 million of restructuring costs and tax benefits and other of $15 million; leaving us with a GAAP net income of $103 million, or $0.21per share, 50 percent better than last year's $0.14 per share. Note that we had an effective GAAP tax rate of about 17 percent in the first quarter, which is our current best guess as the rate for the full year, plus or minus 5 points, down from our earlier best guess of about 20 percent for the year.

Looking at cash, we were pleased with our cash generation in the first quarter, always a weak quarter for cash because of our incentive comp payouts and our up-front pension contributions. In the quarter we had $103 million of income. We generated $40 million from networking capital and other, generating net cash from operations of $143 million. Subtracting $44 million of CapEx and we had free cash flow from operations of $99 million, up from $11 million last year at this time.

Turning to the balance sheet, we had about $59 million worth of depreciation in the quarter and our working capital continued to improve. Our receivables days sales outstanding at 51 days were down 7days from last year at this time. Our inventories at 105 days on hand were better by 2 days from last year at this time. We ended the quarter with $2.48 billion in cash on hand, up $168 million from the fourth quarter and up over $800 million from last year at this time. We're still comfortable with our full-year CapEx forecast of about $160 million and we currently expect depreciation for the full year to be about 250 million.

Okay, turning to the segments. First Test and Measurement. First quarter Test and Measurement orders were $652 million, up 3 percent year-over-year and down 5 percent sequentially. Overall demand in the T & M segment was characterized by strong calendar year-end business in Europe and a stabilizing wireless market, offset by lower seasonal demand in aerospace and defense. Regionally, orders were up slightly compared to last year in the America's and Europe, but were softer in Asia due to weaker handset manufacturing test demand. Sequentially, orders fell in the U.S. due to the seasonality of aerospace and defense, but were up about 5 percent outside the U.S. Communications test orders, about 70 percent of T & M, were $454 million, up 3 percent year-over-year and flat sequentially; with wireless up slightly and wireline down a bit. We saw stabilization in handset manufacturing test orders, however, going forward we expect the market to grow modestly.

We do continue to see some Korean customers add capacity while others, especially second-tier manufacturers, are consolidating in the face of challenges in the local Chinese market. We're seeing modest growth in wireless infrastructure and base stations as operators invest in software upgrades and some capacity expansion. Orders for our wireline test solutions were down 1 percent year-to-year and down about 4 percent sequentially. We think there are significant test opportunities in broadband access, Voice Over IP, and fiber to the home, but frankly, so far things are pretty flat. And in general purpose test, we had orders of about $198 million, up 1 percent year-over-year and down 15 percent sequentially.

We saw the normal seasonal decline in our aerospace defense business after a strong Q4. We continued to gain share in oscilloscopes, especially with our high-speed scopes. And in logic analyzers, we had a higher penetration rate across the board, gaining about 3 points of market share. We did, however, see some softness in some of our basic test instruments resulting from weakness in the semiconductor industry. Test and Measurement revenues in the first quarter were $700 million, up 10 percent year-to-year and down 10 percent from the fourth quarter. Operating profits at $63 million, or a 9 percent operating margin, were substantially better than a year ago at this time by 8.2 percentage points in the operating margin, or $58 million; as we saw the benefits-- the cumulative benefits of our restructuring program over the year. Compared to the fourth quarter, however, profits were down sharply by 6 percentage points. We were hurt by weakness in manufacturing handset test, which is among our more profitable businesses, and which fell more than $50 million from the fourth quarter. Return on invested capital was 12 percent in the first quarter, up 10 points from last year, but down 7 points from the fourth quarter.

Turning now to Automated Test. Automated Test had another difficult quarter with the lowest revenues and profits since the second quarter of 2003, but with a few signs of life in orders. Automated Test orders overall were $160 million, down 20 percent year-to-year, but up 17 percent sequentially. Semiconductor test orders, specifically, were $129 million, down 20 percent year-over-year, but up 21 percent sequentially. As I said, first quarter orders showed a few signs of life, as SOC test had its second consecutive quarter of sequential growth and we saw good growth in parametric test and flash memory test; both year-over-year and sequentially. Overall, we believe the market has bottomed for us, but it is still very soft compared to the strong 2004.

For example, while SOC orders were up for the second consecutive quarter, they were still off nearly 50 percent from last year at this time. And while utilization rates for our 93K testers increased another 5 points during the quarter to 92 percent, normally a level that would stimulate a jump in orders, we expect the rebound to be slow because there's still plenty of excess capacity out there. Utilization rates for our competitor's testers, for example, are closer to 70 percent, and that will impact near-term demand for everyone. The other good news is that the debookings that we saw in the past two quarters has subsided. We had only one material debooking this quarter for $2.4 million, compared to $28 million three months ago. Flash memory orders were up over 100 percent both year-over-year and sequentially, although from a low base. We continue to gain significant market acceptance of our new V-5400 platform, enhancing our position at-- beyond flash at sort. In fact, we're encouraged that about 90 percent of our flash memory test and 16 percent of our SOC test orders are now coming from our new products.

Automated Test revenues in the quarter were $155 million, down 29 percent from last year at this time, down 21 percent sequentially. Book-to-bill at 1.03 is dramatically better than the fourth quarter's 0.7, or last year's at this time's 0.91. During the quarter the segment had an operating loss of $34 million, a $55 million swing from last year at this time, and $28 million worse than the fourth quarter of this year. During the quarter gross margins were depressed by both lower volumes and intense competitive pressures, while operating expenses were relatively flat quarter-to-quarter or year-to-year, as we continued to bring a new generation of SOC and flash memory test products to market.

Turning now to Semiconductor Products, orders were $435 million, down 26 percent year-over-year and up 7 percent sequentially. Without the camera module business, Semiconductor Products orders were $380 million, down 22 percent year-over-year and up 13 percent sequentially. Sequential order growth was driven by strength in optical electronics and wireless, as Ned mentioned earlier. Personal systems orders were $305 million, down 30 percent year-to-year, but up 6 percent sequentially. Again, excluding camera modules, personal systems orders were $250 million, down 24 percent year-to-year, but up 17 percent sequentially. F-bar orders were up 3 percent year-over-year, and up 42 percent sequentially; as major CDMA handset manufacturers showed robust demand beginning of the quarter. And EP hent orders increased 30 percent year-over-year and were up 35 percent sequentially as we saw strong demand from a large European manufacturer.

The weakness was in optical mouse, where orders were down 58 percent from a record quarter last year at this time. Sequentially, however, orders were up 56 percent as we saw demand begin to pick up from our largest customer.

On the networking side, orders were $130 million, down 16 percent year-over-year, but up 7 percent sequentially. Networking ASIC orders were up 18 percent year-over-year and saw a 4 percent sequential increase; while hard copy ASIC orders were down 17 percent year-over-year and down 15 percent sequentially. Fiber optics orders were down 29 percent year-over-year, impacted by the quality issues we have discussed in the prior two quarters. The good news is that in the first quarter we saw a 7 percent sequential increase. We began to put some of these issues behind us. Demand was particularly strong for 10 gigabit products.

Semiconductor revenues in the quarter were $450 million, down 5 percent year-to-year, down 9 percent sequentially. Book-to-bill, at 0.97, isn't quite at 1 yet and it's certainly a long ways from last year's 1.24, but better than the fourth quarter's 0.83 percent. In the quarter we made $27 million, or a 6 percent operating margin. Half of what we did last year at this time as we moved from shortage to surplus, but substantially better -- $19 million better -- than in the fourth quarter of last year. Excluding camera, revenues were $381 million. Our book-to-bill was 1.00. We had operating profits of $15 million. Profitability of the business improved markedly from the fourth quarter as both camera modules and fiber-optics showed significant improvements in quality, yield and cost over the past three and six months.

On February 3rd we completed the sale of the camera module business to Flextronics. The camera module business itself was about break-even in the first quarter, but as you can see by the comparison of operating profit with and without camera, we will be retaining about $12 million per quarter of unabsorbed costs that will depress margins until we redeploy or eliminate those resources.

Finally, turning to Life Sciences and Chemical Analysis, the segment again showed very good momentum on the top line in the first quarter. Net orders of $356 million were up 16 percent year-over-year and down only 3 percent sequentially. Orders for our Life Sciences products were up 18 percent year-over-year and down only 1 percent sequentially. We're seeing good growth for our solutions business from large pharma customers. We're also seeing strong demand from generic drug manufacturers worldwide and particularly in India, Korea, and China. Also noteworthy this quarter, we made the first sales of the 5100-ALP, or Automated Lab-on-a-Chip product in Europe and the Americas. ALP is the industry's fully-automated, high throughput, lab-on-a-chip system for basic life science research and drug discovery.

Orders for our Chemical Analysis products grew 15 percent year-over-year and declined 4 percent sequentially. Our installed base in forensics, chemical, petrochemical, academic, and government institutions continued to drive business in Europe and the Americas; and we saw solid demand in these markets for our analytical instruments. And regulatory initiatives by Asian governments continue to drive demand for test equipment for food, air, and water quality.

Revenues in the quarter were $354 million, up 13 percent from last year and up 1 percent sequentially. Book-to-bill: 1.01, compared to 0.98 last year at this time. Operating profits were $51 million, or a 14.4 percent operating margin, up $4 million from last year, down 5 million from three months earlier. Despite slightly higher gross margins, operating margins in the first quarter were 0.5 point lower than last year because of the impact of acquisitions and a stepped-up level of life sciences investments. Adding back the acquisition impact, operating margins were slightly above last year at this time. And, despite slightly lower operating margins, excellent capital management enabled the segment to achieve a 29 percent return on invested capital in the quarter, up 6 points from last year and 5 points from the prior quarter.

Finally, turning to second quarter guidance, in the press release we provided second quarter guidance for revenues of 1.6 to $1.7 billion and pro forma earnings per share of $0.18 to $0.23. Now looking at the top line, we would normally expect to see about a 5 percent seasonal increase in the second quarter-- in second quarter revenues, assuming flat overall markets, or roughly $85 million quarter-to-quarter in today's environment. Subtracting about $70 million of divested camera module business gets us roughly back to the range of Q1 revenues, hence the guidance.

For spending, I would remind you that the second quarter is where we see the highest expenses on a seasonal basis for the entire year. This year we would expect to see about a $50 million quarter-to-quarter increase in costs due to the 4 percent average wage increase, vacation true-ups and accruals and increased FICA. Obviously, over time it is our job to offset these increases with higher productivity, and in the past few years, we've done exactly that. But quarter-to-quarter, it will show up as higher second quarter spending. Okay, with that, let me turn it back to Hilliard.

Thanks, Adrian. At this time we'll take questions. Operator?

[Operator Instructions]. Stephen Koffler, Wachovia Securities.

If you just sort of looked at the ATE orders as-- ATE and SBG orders as a trend of where things are going, it looks pretty positive. Especially in the ATE part of the business. Could you give some color -- I mean, why such a fast swing? What does it say about the pace of inventory consumption out there? What does it tell us about what your customers are doing and their timeframes for delivery, next-generation products, et cetera?

Well, Stephen, I think as we said before, the issue with-- with our ATE business has been capacity-related. And you know, that's one of those things that can shift very quickly. We think our testers, as Adrian said, are probably utilized about 92 percent of the time. And as a result, when they need capacity, it can turn on very quickly. So, two things drive our business: One is capacity, the other is technology roles. Technology roles you can usually anticipate, but capacity can be pretty volatile. But we do think that our business probably bottomed in Q4, if you look at overall semiconductor test business. We do think it's beginning to come back, but we're trying to signal a slow recovery here because we do think there's still a fair amount of excess capacity out there, particularly if you look at test houses.

Okay, could you just tell us how flash memory testers did? I didn't hear that.

This is Adrian. Flash was up about 100 percent, from a very low base, but obviously we're getting very good new acceptance of our 5400.

Deane Dray, Goldman Sachs.

Adrian in your prepared remarks, when you made reference to that residual $12 million unabsorbed costs from the divesture of the camera module business, how quickly do you think that-- that can be addressed? And is that included in your second quarter guidance?

The second quarter guidance assumes that the majority of that $12 million will still be there. We are redeploying the assets, redeploying the resources, and would hope to gradually get that out of the business, or commensurately higher revenues to cover it, but that's going to probably take the better part of the rest of this year to achieve.

Will that be part of a restructuring charge that we would see?

We're not planning on a restructuring charge at this point to do that. We are hoping that to be able to generate new business with those resources.

Okay. And then can you give us a tour across the product line, especially in Test and Measurement with regard to pricing?

Sure. Pricing is still considerably better than it was for most of last year, but in the last quarter our discounts actually went up by about--

I'm sorry, how much was that?

One point.

Okay.

That was not quite across the board. But it was fairly uniform. Again, the main part of the issue is not pricing, but the volumes in our handset manufacturing tests -- a very good business. It's been a very strong source of growth, but it's really taken a wack in the last six months as Asian the manufacturers have adjusted their capacity. And that's really the predominant reason for the quarter-to-quarter drop in operating margins that you see.

And when you-- with regard to the handset, that expectation for adjusting capacity, is that going to require a 3G pick-up? Will it require just further consolidation? What's the expectations there?

Maybe I should turn this over to Bill to answer that. But frankly, what we had seen in most of last year was everybody assuming that they were going to gain or maintain market share and a couple of manufacturers, notably Nokia, determined to get it back. The result of that was excess capacity that has taken some time to absorb, rather than there having to be explicit rationalization, but let me turn it over to Bill.

As Adrian said, [inaudible]. Right now, as you know, we test 70 percent of the cell phones in the world, so we're very-- very tied into their business [inaudible]. That's number 1. The move to 3G, however, will be beneficial for us because our software [inaudible] out of our installed base [inaudible].

And, again, just in case it wasn't quite clear, while we saw a drop-- a substantial drop in our first quarter revenues from that business, orders were flat sequentially, giving us some confidence that we may be seeing the bottom of it.

And we do expect the orders to improve as we [indiscernible]

Richard Chu, SG cowan.

I had a difficult time hearing a couple of the responses, so I'll look at the transcript. But first of all, if I could get some confirmation Adrian on the SBG numbers. Did you say that the operating profit for SBG, excluding handset -- I'm sorry, excluding camera module -- was 15 million?

That's correct.

Okay, and that-- that includes the absorption of roughly 12 million-plus that you have to carry?

That's correct.

So we ought to look at that as a normalized run rate for current operations assuming volume and pricing does not change?

For the near-term, Richard, that's exactly right. And that's what I think Deane was driving at.

And this is a little bit of a nitpicking, but I wondered if you could clarify the backward guidance and the forward guidance on this point. You had guided to 1.6 billion to 1.7 billion for this quarter-- the quarter that just ended. But somehow my sense was that you contemplated the closing of the camera module sale before you actually did. So in some ways, you had more revenues than you perhaps had expected from that business? Is that a fair statement?

Richard, that's a fair statement. In our guidance we had said we would have the camera module business for about half the quarter. We ended up having it for the entire quarter. That was worth about another $35 million of revenue.

Okay. Can you give me a sense for why SBG -- you touched on this -- but why SBG profits are as good as they seem to be given the -- again, just on the on-going part of the business -- is it-- why margins improved -- gross margins improved as much as they seemed to have?

Gross margins in the business improved because, again, we talked all through the second half of last year about the real difficulties we were having in the pricing versus cost in the camera module business, the quality and yield problems we were having in fiber optics. We've made very considerable improvements in both of those areas just in the last three months. And that's what's reflected in the kind of margins that you're seeing.

Also, cameras were better even though, you know, we had it longer, we had had a bigger loss in Q4 than we did in [inaudible].

Okay.

I want to explain to everyone, we are going to, if we haven't already, posted the SBG numbers both with and without camera first quarter and entire history. So you should find that on our website to help you renormalize your models.

Can you give us a sense of where head count stands with and without the-- on an apples-to-apples basis, adjusting for the camera divestiture?

I can't, Dick, it was just under 28,000 total employment. I forget how many were associated with the camera module divestiture. It wasn't very many initially, something like 20 or 25. And that's why we have a residual-- one of the reasons why we have a residual $20 million issue going forward that we're going to work out.

Part of the residual too is-- is in manufacturing. We have a lot of temporary people and some permanent people in Penang that were involved with camera modules. And, you know, given attrition rates and growth prospects in other businesses, our assumption is we'll be able to absorb the bulk of those people, and that's several hundred-- [inaudible].

Teran Conna (ph), Wellington Management.

Adrian, just a quick question on the options issue. A lot of companies, obviously, moving toward expensing options and I think Agilent has to take a big bite out of earnings and I'm curious as to what the final verdict is on this frontal management here as to how you guys are thinking about this whole thing.

Well we will expense options when we are required to, which is in the fourth quarter of this year. And we indicated in the analyst meeting in December that the hit from the options may be less than you might expect. We will have the massive bow wave of initial options at very high prices behind us by the time we implement. We believe that order of magnitude -- the cost, obviously non-cash cost -- of options expensing is in the $130 million range; beginning in 2006.

Okay, and just a follow-up question for Bill Sullivan. And that is you know, as you kind of inherit this portfolio, and you come in as CEO, and I'm just curious as to what you're thinking in terms of, you know, the businesses that you're getting. Because I look back at Agilent and it feels to me like it's a collection of really good assets, but there's always something that's working and there's always something that isn't. And that always seems to lead to, I guess, to underperformance in the stock price. And I'm just curious as to how you're thinking about the portfolio that you're getting and are you thinking about any kind of divestitures or perhaps acquisitions in other areas to kind of beef up areas to reduce the cyclicality of this company?

I'm very fortunate to take over the Company from Ned, where it has been a very sound position. We have gone through the restructuring of the Company. We've transformed everything in the Company from our IT systems to eliminating 5 million square feet of space. As I said in my opening comments, we are absolutely committed to reach our long-term model of an operating margin of 14 percent, a return on invested capital of 21 percent, and we will continue to make business portfolio reviews and decisions accordingly to be able to hit that model.

Brett Hodess, Merrill Lynch.

Along those lines on-- on the operating margin, I'm wondering, you know, given that the R&D and SG&A numbers were a little bit higher, although partly from currency, what the thought process is as you run through this year in terms of the trend line on those numbers? Will you continue to keep those focused on projects and what-not? Or would we expect -- would we expect to see some revenue-driven increases in those as well?

No. I think what we are trying to imply earlier was that we're going to toggle a little around our long-term operating model. We're not going to react to every seasonal adjustment in our revenues. So, go back six months ago when we were below our operating targets for R&D and SG&A. Now we're slightly above them because revenues dropped $164 million. We will have an increase from Q1 to Q2 associated with the cost increases that I mentioned earlier, but beyond that, we intend to keep them, in real terms, very flat going forward at least for the remainder of this year-- at least and until we have a lot more confidence that the top line is taking off.

Ajit Pai, Thomas Weisel Partners.

A couple of quick questions. The first one would be on the Test and Measurement side. You talked about general purpose test orders being generally flat. Can you give us some color there because, you know, your competitor-- or one of your smaller competitors in that space, Lacroix, reported some very strong order growth. So just want color on whether you're seeing -- whether you're losing share there or not?

Well, remember, when we talk about Test and Measurement, or general purpose, we're including lots of things in that category. If you look at our oscilloscope business, just isolating in on that, we've done very, very well. We think we've gained share in oscilloscope and the response to our new products has been excellent. We also think we've been gaining share in the logic analyzer area.

I think one of the other things to remember, again, Agilent's in a lot of businesses. General purpose test also includes our laser innerferrometers that are used in wafer steppers. So, guess what, when the semiconductor industry slows down, we actually see a little bit of a hit in that. And then we also have seen a hit in our EEsof software business, again, largely related to slow a down in the semiconductor-related industry. So, it's those kind of businesses, not so much our general purpose instruments or certainly not our oscilloscopes or logic analyzers. Those are doing very well.

Okay. The second question would be in the Automated Test business. Could you give us an indication of what percentage of that business came from the IBM flat-panel, you know, display products? And whether you-- for both orders and revenues?

Well, at this point in time, it's just getting started. This was our first quarter and, you know, at this point in time we're talking about less than $10 million-- for the quarter. Now, we expect it to ramp as we go through the year and we are starting to see -- remember we acquired IBM's business but we also, for the first time started seeing orders for our own internal developments. So, we expect it to ramp as we go through the year, but it's still very small right now.

And then the last question would be about Lumileds. Within-- how have you reported for Lumileds profits in your income statement and do the SBG segment profits include what you're getting from Lumileds?

No, not for the SGE segment because we only report down to operating profits. If you were to look down to their pre-tax income, it would include it because we-- and where you would find it is in our consolidated statements and other income net. And you would see year-to-year that we had $26 million this quarter. I think it was $11 million or $12 million a year ago. And the-- almost -- or much of the difference is the improvement in Lumileds. So that's where you're going to find that reported.

Mark FitzGerald, Banc of America.

In the Test and Measurement business, the drop in operating margins quarter-to-quarter, is that all volume or was there pricing issues there?

Mark, it is largely volume but, as I reported earlier, we had a 1 percentage point increase in the average level of discounts from the fourth quarter to the first quarter. So that, obviously, came right out of margins as well.

Okay. So, basically, when we look at that, that's pretty reflective of the kind of leverage that the business has at this point? So if you were back up at $780 million, you would be doing 15 percent operating margins?

If it all came from the one-box tester, absolutely.

Okay, and just a detailed question on the share count here. The drop in share count, can you give us a quick explanation on that one?

No. In fact, I'm not aware of a share drop.

Oh, maybe I didn't get plugged into the model.

I think we're at 531 fully diluted shares in the first quarter.

Okay, my model's not updated. Sorry.

Edward White, Lehman brothers.

Yes, on the Test and Measurement operating margin and leverage, you know, it appears as though a lot of the leverage is because -- as you mentioned, the higher margins on the wireless test area compared to other products. And I was wondering if there's anything you can do about that so that your margins would be less sensitive to what happens on the wireless test side?

The wireless business today is a very large percentage of our overall business. And so when we see a drop as we did, as Adrian described, a $50 million quarter-to-quarter drop, there's very little we can do in a short period of time. Overall, though, we continue to try to diversify our investment into more R&D solutions that are not as cyclic as the manufacturing part of the market. Essentially in the test and measurement market, half the market is in research & development and half the market is in manufacturing. We have always had a very large market share on the manufacturing side. We've done quite in the R&D side, but we continue to make investments on that side of a customers' requirements to be able to have more stability and more flexibility when we see a drop such as we have had in one-box testers, cell phones.

Okay. And, you know, as you look through the rest of the year, what do you think will happen in that part of the business, the wireless market in Asia? I know it's weak now and it's gone through its period of weakness and there's some excess capacity there, but are there some issues that you think could turn that around as we go-- as we go through the rest of the fiscal year?

83 percent of all cell phones are manufactured today by six manufacturers, and they're all very, very large companies, all with the capacity to attempt to take market share from one another. So overall, if the overall market increases throughout the rest of the year, then I think we're going to see a continued investment in capacity expansion. If one or two of the individual companies loses market share, I think that we could easily see a disruption in the overall capacity buildout. The good news that I had mentioned, however, is that with the rollout of G3 and other standards, we will be able to have, you know, relatively high or very high margins as we upgrade our existing installed base with the latest version of software to test the next generation of cell phones.

Okay. And then in the Automated Test group, can you talk a little bit about the degree of success you're beginning to see or if you're seeing any on the D-ram test side? I know it's early for that product, but can you talk about what your customers are saying and how the-- how the initial reaction is?

Well, the initial reaction has been very favorable, but again, as you say, it's still too early. These things take a while. There's large installed base, a fair amount of momentum there. So we really haven't seen any significant business there yet, but we certainly expect as we go through that-- through the year that we'll see some success there based on the initial response.

Mona Arabi (ph), Rosetta Group.

Yes, question related to the ATG business. I think you mentioned the release becoming significantly more competitive. Could you elaborate on that and which area and which products that you-- are seeing intense price competition or what's exactly happening?

Yes, what's happening is that the level of business and orders has dropped, depending on the company, by anywhere from 25 to 50 percent. And so there is just an enormous incentive on the part of all manufacturers to want to gain share in that environment or not have to engage in draconian steps as they try to keep the cash flow going. And so just the level of competition has gotten absolutely fierce. As I mentioned earlier, we've seen over a 15-point drop in our gross margins year-to-year in this business, and it's not because our products are less competitive or less in capability. In fact, we're rolling out a whole new set of new products. It's just a very, very tough environment out there. It is mostly SOC, but certainly not exclusively. Flash is also very intense competition.

Richard Eastman, Robert W. Baird.

Just two questions. Within the SBG business, could you just characterize where we stand in the optical mouse area and also in the hard copy ASIC business? How would you view those businesses at year-end and maybe what the delta in revenue that you would expect in those two businesses?

Let me say a couple of things about it. First of all, in the optical mouse, as Adrian said, you know, that business dropped--

58 percent.

-- pretty dramatically year-to-year, 58 percent. And I think there's a couple things going on there: One, obviously, there's a lot more competition now, a lot of competition coming from Asia. So we're really working hard to make sure that we protect our intellectual property. But at the same time, as you know, we introduced the laser mouse, which gets us into a new high-end category. So, I think you know, we still believe this is a good business for Agilent. But clearly, it's going to be a very competitive business going forward. In terms of the ASICs, the HP-ASICs for printers, you know, that's-- that business is about flat. I think it's off a little bit on a year-to-year basis--

17 percent.

-- yes, 17 percent. But, you know, it goes up and down based on seasonality of-- you know, of the market and whether we're designed in to some of the new printers or not. So not a huge amount of growth there, but-- in the short-term. But we do see ourselves playing a bigger role in some of the future printers, providing more complete solutions through HP. But, at least in the short-term, that business is going to oscillate up and down a little bit, based on just the seasonal effects.

Okay, and then just maybe a secondly, just from a big-picture standpoint. I think the commentary a few months ago was SBG and the ATG business, the sales forecast for '05 you know, looked to be flat. ATG might be down about 10 percent. It would appear in this quarter that-- that I don't think we're far off track, but is there any revision to your outlook based on the first quarter results for those two businesses?

No. You're right. So far -- and it's still early -- the markets seem to be tracking to our fundamental hypothesis, which is that this was not a massive new downturn ala 2001, but a classic mid-cycle adjustment that was going to take six to nine months to occur. If you want to be an optimist, you can take a look at the orders in both SBG and ATG and construct a hypothesis that that transition is ending. It's probably going to stay quite weak for another quarter, but then, if we're right -- and again, we've been tracking channel inventories, we see them down a lot. End use market inventories are much better it was a good Christmas season. We're still fairly confident that we will see a pick-up in those businesses in the second half of this year but that, overall, the markets will be about flat for semiconductor products year-to-year. Down about 10 percent for semiconductor capital equipment and when you're trying to extrapolate that into our business, please remember the impact of the camera module divestiture.

Things will turn fairly quickly, as we talked about earlier, as people held off in buying-- making capacity purchases. Somewhere out there we do think we'll see a reasonably good-- good pop. The question is whether that's going to be in Q2, Q3, Q4. We're assuming that probably another quarter of relatively modest growth before we see any strengthening in markets.

Paul Coster, J.P. Morgan.

A few very quick questions. First of all, Adrian, latest thinking on the cash and what you will-- you intend to do with it? And the related question, on the financial side, can you just repeat what you see the tax rate being this year?

Sure. We expect at this point a GAAP tax rate of roughly 17 percent, down from our prior guidance of about 20 percent. Both of those are plus or minus 5. And for the pro forma tax rate, we had a 24 percent in the first quarter. That was our guidance for the full year and we're still comfortable with it.

On cash, clearly, it is now beginning to mount up rather significantly. Even Ned's starting to smile-- that it's enough. We don't have any specific plans for the cash at the moment, but I think it is going to increasingly be a subject of conversation with the Board. As always, we have said that first you reinvest in the business, second you do fold-in acquisitions -- and you've seen some of those, especially from the Life Sciences and Chemical Analysis side, that we think is the most fertile. Then after that, become share repurchases and/or the debt, depending which economics makes the most sense, and that's about as far as we'll go.

Okay. Can you share any information on the OSS business at the moment, how that's going?

The OSS business is pretty flat. It had a good year last year. I think, off the top of my head, it was up some 23 percent. And it was flat in the first quarter compared to a year ago, so there's a little bit of a pause. But we are still pretty optimistic that that is going to show decent growth this year.

Okay. And the last question is, maybe you've already divulged this, but what percentage -- how does the personal systems business break out in terms of the mouse business and the ASICs for printer controllers and so on? Can you give us any breakdown now?

No, we don't give the subsector breakouts for those.

John Harmon, Needham & Company.

A couple questions. First of all, you said in your fiber optics business you'd solved most of the issues you had last quarter. What's still to be done? Is it a manufacturing or yield issue?

I think the-- as we've talked to you, we've had quality issues and-- and yield issues. We've actually addressed a large portion of the quality issues. I think we're back shipping again to our large customers. The yield is back up close to where we would like it. I think the big challenge for us is, frankly, the margins aren't where we would like them, and we are working hard to get the manufacturing costs to a better place and, frankly, that's going to take a little longer. But, in terms of the short-term, the yield and the quality issues are pretty well resolved; but lots more work to do on cost structure and overall manufacturing costs.

And then, secondly, on your lab-on-a-chip business, how has the initial customer reaction been? Are they cautiously testing it or is this a product they've been waiting for for some time?

Are you talking about--

ALP.

Oh, the new ALP-5100. Actually, that's been very well received. I was just in Germany last fall, talked to a number of the pharma companies. This seems to be really hitting a real need in the marketplace for high throughput, genomic kind of experiments. And so it looks like it is going to take off well, we're having a good early response. These things do take a little while, however, before you start seeing the actual orders, so the order ramp is still slow, it's still pretty new. But we expect, again, as we go through the year this will have a pretty significant impact on our business in Life Sciences.

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

Thanks, operator. I'd like to say congratulations to Ned on his retirement, we will definitely miss him. And we look forward to all of you joining us in May when we announce our Q2 results. 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.