安捷倫 (A) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2006 Agilent Technologies, Inc. earnings conference and analyst meeting. My name is Jessie and I will be your coordinator for today's call. At this time all participants are in a listen-only mode and we will be conducting a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Hilliard Terry, Investor Relations Manager.

Good morning. Hopefully everyone on the line can hear me clearly. Unfortunately due to some of the storm-related challenges today we have half of our team here in New York and half of our team participating today remotely from Palo Alto. So with that let me make a few introductions. Here in New York I have Tom White, President of our OSS business; Pat Byrne, President of our Electronic Measurement Group; Craig Nordlund, Senior Vice President and General Counsel of Agilent Technologies. In Palo Alto we have our CEO and President, Bill Sullivan; our Executive Vice President and Chief Financial Officer, Adrian Dillon; and also Chris van Ingen, President of our Bioanalytical Group.

With that let me start with our Safe Harbor. We may make some forward-looking statements today and we ask that you take a look at our SEC filings to make sure that you understand the risks and uncertainties associated with those statements. Also in accordance with SEC Regulation G, if during this call or meeting we make any non-GAAP financial measure references, you will find in your books here in the room, and also on our website, a reconciliation to the most directly comparable GAAP financial measure.

In addition, the forward-looking statements that we make today are only valid as of this date. The Company assumes to obligation to update such statements as we move through the quarter. So as we proceed today I ask for your patience. We're going to take questions from here in the room, also on the line. And as many of you in the room know, we've been having a few technical difficulties, which just means that there's still a use for Agilent's test equipment. And as many of you know, our name is Agilent and today we are being very agile. So with that let me turn it over to our President and CEO, Bill Sullivan.

Thank you, Hilliard. It's a real pleasure for the team to be here either live or virtually to welcome you to our 2006 analyst meeting as well as our Q1 conference call related to our performance in Q1 of 2006. Today I'd like to just give a quick snapshot of where Agilent is today. On August 15, 2005 Agilent announced the strategic realignment of the Company; the purpose was to provide more focus as the world's largest measurement Company and to create more value for our customers as well as our shareholders. We are very pleased today to -- during this update to report that we have made excellent progress since that announcement.

Today Agilent is more focused, we're two times larger than our nearest competitor as the largest measurement Company in the world, we have made substantial progress in meeting the commitments that we have made, we have a robust productline, product offerings moving into the future. I think some of that was clearly demonstrated in our Q1 results. We're strong, very financially strong, and have an excellent operating model in which to leverage our performance moving forward.

So what you're going to hear today as well as the update on our Q1 performance is Agilent is essentially moving into phase two of its evolution to really be able to leverage our top-line growth in order to return superior shareholder returns based on the strong operating model we have created.

Let me just give you a quick update on the actions we have taken since the August 15th announcement. First of all, in September of 2005 we did call our $1.1 billion convertible debentures and that has been completed. Likewise in November we sold our share of our Lumileds joint venture to Philips for $1 billion. In December we completed the divestiture of the Semiconductor Products Group to KKR Silver Lake Partners for $2.7 billion and we have completed $3.3 billion of the $4.5 billion stock repurchase. It is highly likely, pending assuming normal market conditions, that we will complete the stock repurchase program by the end of this year.

And finally, we are right on track to complete the spin-off of our SOC flash memory test business which has been named Verigy and that IPO is expected in the middle of this year. So overall we continue to meet the commitments that we made on our August 15th announcement.

So if you look at Agilent's strategic priorities moving forward, our focus, our strategic intent is very straightforward. We want to be and are the premier measurement solution partner to every engineer, service provider and scientist in the electronic and bioanalytical market. That partnership is the result of the quality of people that we have in a very high-performance results-oriented company.

The foundation that we go back for 65 years is built on uncompromising integrity and Agilent moving forward is about speed and innovation that our employees will provide that partnership to customers everywhere in the world. We strongly believe that this focus will continue to create long-term shareholder value which is measured through superior return on invested capital and above market growth.

If you look at the overall measurement market, and we have shared this with you in the past, it is a $40 billion market opportunity for us, $20 billion in electronic measurement and $20 billion in the bioanalytical measurement side of the house. And as you can see from this slide, there are many segments of the market where we believe that we will be able to leverage our expertise in order to be able to grow faster than the market. And that will really be the subject of discussion by each of the group presidents when they talk about their strategic initiatives.

So if you go to the next slide, you can see the brief outline of the key strategic initiatives that we will discuss later today. Chris van Ingen will talk about the bioanalytical measurement opportunities, continuous strengthening of our core product portfolio, our continued investment in life science tools and high-end mass spec portfolio and opportunities that we see in aftermarket consumables as well as informatics.

Likewise Pat Byrne and will continue to focus on opportunity in communications, triple turbo play, emerging wireless opportunities, aerospace and defense and our whole effort to expand our market position in general instrumentation. And finally, Tom White will talk about our efforts to expand our leadership position in network assurance as we move into service and customer insurance. And again as I stated, our overall goal is to outpace the growth of the markets while continuing to leverage the excellent operating model that we have been in place.

In addition to that we will continue to actively look for acquisitions to be able to enhance our product portfolio and improve our growth. Our goal is to be able to grow the Company by 3 additional points through M&A. In the last five quarters, even with all of the transformation that we have been managing through, we've actually made six acquisitions that we believe can add 2 points of additional growth over the next three years. These acquisitions are evenly split between our electronic measurement sector and our bioanalytical measurement sector.

Just to highlight a couple, our Qianfeng instrument JV is our effort with a joint venture to be able to have a very cost-effective high-quality, low-cost RF instrumentation offering. And again, the first products will start to roll out next quarter. Likewise we entered into the nanotechnology marketplace with the acquisition of Molecular Imaging. And finally, in electronic measurement we've expanded our RF EDA software with the acquisition of Eagleware. And all of these acquisitions are going very, very well.

Likewise on the bioanalytical side we have made two acquisitions, Silicon Genetics and Computational Biology, to be able to expand our product offering in gene expression. And with the addition of scientific software, we have a much stronger, broader offering in lab informatics. Agilent will continue to actively look for acquisition opportunities while ensuring that we generate 20% incremental return on invested capital by year three.

It is so important as we focus on growth to not take our eye off operational excellence. We've been very pleased with the progress that we have made over the last year. First of all, in terms on return on our research and development investments, almost 30% of the revenue we are generating today are product that have been released over the last two years.

Likewise for the second quarter in a row we had a return on invested capital of greater than 20%, our asset management continues to be best in class, and we're -- and Adrian will go into the details, but we're well ahead of schedule of getting our infrastructure costs out of the system, getting to cost parity given that the Company now is more focused and smaller than it was before without the semiconductor group. And of course we'll continue to return value to our shareholders and to date have repurchased 18% of our outstanding shares and, as I had mentioned previously, we will complete, given normal market conditions, the rest of the committed stock repurchases by the end of the year.

So in summary, the transformation of the Company is going exceedingly well. 2006 is all about consolidating our position and focusing on top-line growth while leveraging our operating model. We think we are very strong in our overall product portfolio and we are continually committed to making sure that we maintain our operating discipline as we focus on the top-line growth.

Before I turn it over to Adrian I would just like to say a couple words about our Q1 FY '06 performance. Overall FY '06 Q1 was a very solid performance, revenue and earnings per share were at the high-end of our range adjusted for the outstanding shares. If we could do anything better we should have turned more of the orders in our electronic measurement sector into revenue, but the good news is we have a lot of momentum going into Q2 and we believe we are positioned to perform well in Q2 and have provided the guidance of an earnings expectation -- again, this is pro forma -- of $0.35 to $0.40.

With that I'd like to turn it over to Adrian to give you the details of Q1 as well as the outlook moving forward. Adrian?

Thank you, Bill. Good morning, everyone. It is a pleasure to be with you even if virtually, and we all wish we could be there in the 27 inches of snow with you. Let's begin by talking about the first-quarter performance and then we'll transition to our longer-term operating model. As Bill has already said, we believe we saw a solid performance in the first quarter while completing several major transactions. We did complete the $3.7 billion worth of semiconductor-related divestitures in the past three months for a gain of $2.74 billion. We returned $3 billion to our owners through a very successful self tender.

The growth in orders, which orders were up 15% in the first quarter from last year, the growth was driven by the rebound in semiconductor tests, but new Agilent -- in other words excluding semiconductor tests -- orders were also up 8% from last year. Our revenue and operating earnings, revenue of $1.34 billion was at the -- near the high-end of the guidance of $1.28 to $1.35 billion and our earnings were at the high-end of expectations.

We actually reported $0.32 per share versus guidance of $0.25 to $0.30 per share at 512 million shares outstanding. In fact, because of the success of the tender offer we ended up having 483 million shares on average outstanding during the quarter, so that $0.32 equilibrates to $0.30 at 512 million shares. So we did achieve the top end of revenue and earnings despite some customer acceptance delays due to the Chinese New Year holiday, as Bill has already mentioned.

The focus, while we're continuing to perform on the top line, we're also performing on the bottom line. The focus on operational discipline does continue. We saw the highest gross margin in five years during the first quarter at 52.7%. We've hit a first-quarter record low for working capital ratios. And even in a seasonally weak quarter like Q1, we hit our 21% return on invested capital target. With the backlog that Bill mentioned and the momentum we've got in the business and particularly with the major new product ramp that we're seeing in bioanalytical, and that I'm sure Chris will talk more about, we are excited about the prospects for Q2 and the remainder of 2006.

Turning now to some details of the operating results, on the next slide. What I'm showing you here is the four quarters of 2005 as restated to exclude semiconductor products and the first quarter of 2006 and then the year-to-year comparisons in the seasonally weak first quarter were $1.35 billion, up 15% from last year. Within that the Americas was up about 6%, Europe was flat and Asia-Pacific orders were up 35%. So a total blend of 15%. And by the way, in local currencies that order growth would have been 18%. We had about a 3% negative impact of the stronger dollar on our orders and revenue results.

Revenues of $1.34 billion were up 10% from last year. Gross margins, as I mentioned, were up almost 3 points from last year at this time on an apples-to-apples basis to 52.7%. R&D was up 2%, SG&A was up 3%. As you can see, R&D compared to last year was down 1.1 points as a percentage of sales; SG&A was down 2 points compared to last year at this time. As a result we had $164 million of operating profits or $85 million more than last year at this time on a $124 million increase in revenues or a very attractive 69% incremental. 12.3% operating margin is nearly 6 points above last year at this time.

We also had good other income mostly because of net interest income. We had $31 million of interest income this quarter, 10 million of other net income equal to last year's results. Pretax earnings $205 million, 25% tax rate achieves the $154 million of pro forma net earnings or $0.32 per share. And as mentioned, 21% return on invested capital, double last year. Inventories at 108 days, 13 days better than last year at this time, so obviously the secular improvement in inventories continues. And our DSO performance, which has always been good, improved by one day from last year. Total result $0.32 per share compared to $0.15 last year at this time.

A couple of other data points for you. Capital spending in the quarter was about $50 million and that's obviously in part to begin the transformation of our semiconductor test business as well as investing in our new corporate facilities down in Santa Clara. Depreciation and amortization $43 million during the quarter. Net cash and short-term investments, we have $2.737 billion of cash and short-term investments plus $1.6 billion of restricted cash or $4.338 billion of gross cash, subtract off the $1.5 billion of debt and our net cash and short-term investments was $2.838 billion at the end of the first quarter.

Okay, next slide. It was a very good quarter operationally, but there were a few other things going on at the same time, so it's important to reconcile to our GAAP earnings per share. Starting out with $0.32 of earnings per share on a pro forma operating EPS basis. We had gains from the divestiture of the semiconductor products business and Lumileds equal to $5.67 per share. We had restructuring charges mostly for semiconductor test systems and to reduce our infrastructure costs consistent with the message and the plan that we profiled first for you last August. That was worth $0.07 per share. And equity related compensation was $0.07 in the quarter.

Now that's a little bit higher than we had said because it was front end loaded. Agilent's plans allow for immediate vesting of retiree eligible employees. So if a retiree eligible employee gets a stock option it vests immediately and we have to recognize 100% of that expense immediately. So it was front loaded a little bit; it was $36 million in the first quarter. We're still comfortable with the full-year estimate of about $112 million pretax for equity related compensation or, as we said before, roughly $0.18 per share for the year. Tax and other was about $0.02, that gets you to the GAAP earnings per share of $5.83 or $2.816 billion.

Okay, a few highlights from the segments. And you'll hear much more about this from Chris and from Pat and from Tom, but starting with bioanalytical measurement. We had mixed demand across the businesses and geographies. Orders of $378 million were up about 6% from last year. Currency hurt this segment quite a bit, the impact here was about 5%; and other words, in local currency terms orders were up about 11%. Back to the 6% total, about 9% of that was from life sciences at $164 million, about for% growth from Chemical Analysis to $214 million of orders.

Total Pharma was up about 4% year-to-year. Modest orders from traditional U.S. pharmaceutical customers continue to sort through the difficulties that big Pharma is having. But we saw that mostly offset by continued strength in Asia driven by generic manufacturers and contract research organizations which are picking up an increasing share of this new activity.

We also saw very solid performance in Chemical Analysis as food quality, water quality and environmental needs really drove growth, especially in Asia. That was offset just a little bit by delayed service agreement renewals and I think a little bit by the prospects for the new LC platform that we've just announced.

Operationally we had a 1 point improvement in gross margins but that was essentially offset by a 9% increase in operating costs from acquisitions and from the new product introductions. And so we had an operating margin that was about flat with last year at a very attractive 14%. 28% return on invested capital illustrates the continued operating discipline in this business, down 1 point from last year.

Where do we go from here? We are positioned for a very strong new product ramp in 2006, the 1200 series of LCs that I just mentioned, the open lab software that Bill mentioned, the ion trap and single quad mass spec products that are coming in. And by the way, just after the quarter end we bought out our 49% partner, Yokogawa Electric's share of our Yokogawa Analytical Systems JV for $98 million. Again building the strength, particularly in Asia, in this business.

Turning next to electronic measurement. We had solid demand for the large wireless customers in Asia, but that was partially offset by a softer wireline business. We have seen about three consecutive quarters of rebound in the wireline business but it went flat again in the first quarter. So orders in total were about $799 million, up 8% year-to-year. Currency affected us by 3 points, meaning in local currency we were up 11% year-to-year. Back to the 8% total, comps test was up 6% year-to-year with wireless up 7% and wireline actually down 1% from last year. And with strong growth in general-purpose, general-purpose orders were up 12% year-to-year paced by our refreshed expanded oscilloscope offerings and a still strong seasonally strong Aerospace defense business.

We saw modest revenue growth, as Bill mentioned, of 2% year-to-year due to acceptance issues in Asia and to lumpy OSS revenue. Again, we lost two days of Asia-based revenue due to the Chinese New Year falling in the last two days of the month. It's not that we didn't ship the product, it was that nobody was home to receive the product; so obviously that turned into backlog. Backlog is up 10% year-to-year to the highest level we've seen in a year and a half. So we feel pretty good as we enter the second quarter.

I wanted to emphasize the continued strong operational performance in this business. Gross margins were up 4 points year-over-year to 55%; OpEx was up only 4% year-to-year; and our return on invested capital therefore improved by 7 points to 18% in a seasonally weak quarter. So good performance by this business.

Finally, in the semiconductor test solutions business, a very strong quarter. I'm going to tell you at the outset here that we have to be careful about what we say about this business both now and for the remainder of the presentations because we're within a month of filing the S-1 documents to the SEC. So we're absolutely prohibited from talking at all about any forecast for this business. So this is all strictly about what happened in the first quarter.

But STS did meet its commitments in the first quarter to operating performance and to the business transformation that we began to describe in our August meetings and again in the fourth quarter -- in our fourth-quarter report. First-quarter orders were up -- were $176 million, up over 100% from last year. Our SOC orders were up 114% with more than 80% of those orders being our new Pin Scale platform. And by the way, utilization of Asian SCNs in the first quarter averaged 96%.

Memory -- test orders were up nearly 100% and virtually 100% of those orders were for our new V5000 series of memory test where we can now test both NOR and NAND flash in both short and final tests, so really almost a quadrupling of the available market through these new Versatest systems. Revenues of $169 million were up 117% from last year; clearly the market is rebounding and we're taking full advantage of that. Our book to bill in the quarter was 1.04.

Because of the higher revenues and continued progress in transforming the operational structure of the business, gross margins doubled to 44% and that's despite an $8 million E&O charge. Operating expenses were flat versus last year illustrating the operation discipline. And so our operating margin was better than 9% in the quarter and return on invested capital in the quarter was 17%.

And as I've already indicated through the results, the business transformation is underway and tracking to our goals. We've made explicit decisions about reductions in headcount, changes in compensation to make compensation for everybody more variable with the cycle in this always cyclical business and consolidating sites down from six to two or three. We're also building a leadership team and getting the business processes aligned to those specifically of a semiconductor test business rather than a measurement company business. And we are on track for a midyear IPO and a final distribution of the shares, all shares before our fiscal year end.

Okay, talking briefly next about our global infrastructure operations. As Bill mentioned, we are making excellent progress in reducing the size of our infrastructure commensurate with the 30% reduction in volumes that we're seeing from this transformation and from the focus to a pure play measurement company rather than that of a diversified technology company. We talked in our August 15 presentation about reducing annual GIO costs by 35% to $850 million per year, that is on track. Headcount reductions will be about 35% or 1,300 heads. That is in fact ahead of schedule.

And we're not just going to get to parity; getting to parity would not be sufficient for what we think is sufficient for what we think is the opportunity we have to focus the infrastructure organization to this pure play company. We're going to reduce infrastructure costs 1 percentage point of revenues below where it was previously contributing that 1 percentage point to our bottom-line operating margin. We're eliminating 11 major sites completely, 25 plus sites will be impacted. As Bill mentioned, we are ahead of schedule in getting to parity. We previously said that we would be at about 85% of parity by fiscal '06 and at parity by year-end. We now expect to be at parity half a year earlier. We'll really be able to snap our fingers and say we're at parity by the middle of this fiscal year and we'll be the full 1 percentage point better than parity clean slate savings completed by early 2007.

As far as estimated costs of all of this, they are just about the same as we mentioned and profiled last August, about $225 million of total restructuring costs in cash, that is; workforce management costs of about $80 million; sites and facilities of $70 million; and IT investments both for STS and for Agilent of about $75 million. In the last month we've realized about $88 million of cash from the sale of proceeds. We expect conservatively to realize at least $275 million of proceeds as part of this transformation. So short version is we are ahead of our original schedule and very pleased and optimistic that we will be able to achieve the full potential of this focus on being a pure play measurement company.

Okay. Before turning to the outlook for the second quarter and fiscal year 2006, let's look at how our first-quarter results compare to our secular operating model. Whether you're looking at total Agilent or new Agilent, the world's premier measurement company, meaning minus STS, today we are at our secular model even during the seasonally weak quarter. As you know, we've had a secular operating model that says we would achieve 10% growth on average over time, about 7 to 8% from organic growth, the secular growth of our markets and, as Bill mentioned, 2 to 3 points per year from acquisitions. We have a gross margin with this pure play model of about 53%, dedicated R&D over time of about 12% of revenues and SG&A for this very high touch direct sale business of about 27% getting a secular operating margin of about 14% and if we have a 25% tax rate we get a net margin of 11% or a 21% return on invested capital.

What we're showing you in the next two columns is how the measurement business did -- electronic measurement segment did in the first quarter; how the bioanalytical segment did in the first quarter, add that up to the new Agilent and, as you can see, we did not achieve in this particular quarter the revenue growth. And that is the strategic challenge for the Company, ensuring that we do hit that 10% secular growth.

But notice, even with relatively modest growth gross margin above our secular targets, R&D and SG&A almost at those targets and those will improve to our target levels as we complete the GIO restructuring. But even so we hit a 13% operating margin virtually on target. Net was 12% and return on invested capital, because we are achieving even better than expected asset velocity, we are achieving a 22% return on invested capital with only a 13% operating margin.

Then you add STS to the mix and, as you can see, the total Company in the first quarter did indeed achieve the secular operating margin or model of 10% top-line growth, 53% gross margins, 12% operating margin, 21% return on invested capital. Clearly what this suggests is that we have achieved an operating model that is robust and the strategic opportunity for us all is to accelerate the top-line growth while keeping this operational discipline.

Okay, let's turn next to the 2006 macro outlook and our market assumptions for providing guidance. We believe we're probably half way through what will be another extended worldwide business cycle. The world is clearly transitioning from the initial acceleration of the first few years to a more mature business cycle, getting its second wind after the inventory related adjustments of 2005. But to be clear, there are no signs of impending downturn, but also we can't expect any major acceleration after three to four years of economic growth. So we're essentially transitioning.

High-tech in particular, last year at this time we were talking about -- we were about to go into a classic midcycle inventory adjustment particularly in the semiconductor industry. That clearly did happen, but now the industry is coming out of it. Semiconductor worldwide shipments should accelerate from 2005's 7% growth to 8% growth this year. That as always is the case, will affect semiconductor tests as the first derivative of semiconductors, with semiconductor tests industry wide expected to grow about 25% this year after 2005's 20% decline.

We pointed out last year that electronic measurement markets tend to lag the semiconductor industry very consistently with about a six-month lag. If you think back six months ago, the semiconductor industry was just beginning to bottom out. It is now clearly regaining momentum. And we're beginning to see that translate into building momentum and electronic measurement as well. So while overall for the year it will be a relatively modest growth year, we will gain momentum throughout the year.

And for the bioanalytical sector, we see essentially unchanged secular growth at about 8% this year with difficulties in big Pharma largely being offset by the continued growth in generics and the sustained strength in industrial markets by which we mean of course the infrastructure markets, the environmental testing, food testing, commodity materials, petro chemicals, etc.

How does that translate into numbers? For Agilent, next slide please, we have fiscal year 2006 market growth assumptions, looking first at the electronic measurement segment -- last year had revenues of about $3.3 billion or 64% of Agilent's total. We think the market will grow about 5% this year and that we will grow at least 5% this year. That bioanalytical, which is about 28% of '05 revenues, market will grow about 8% this year, but because of the new product platforms that we have and our penetration and particular emphasis on Asia, we think that we will outgrowth the markets significantly this year, 13% revenue growth versus 8% for the overall market.

So the new Agilent will modestly outgrow the markets, 7% forecast for our segments versus 6% for a weighted average of our markets. Semiconductor test markets, about 9% of our revenues last year, are forecast to grow by -- according to industry experts about 25% this year and we are not going to comment on what STS will grow this year because, again, we are in the quiet period and we don't want the SEC to construe that we are in anyway touting Verigy.

Okay, so guidance. For the second quarter revenue range of about $1.37 to $1.43 billion. In other words, up 6 to 12% year-to-year from last year. Non-GAAP earnings per share range $0.35 to $0.40 per share or more than 100% better than last year at this time on an apples-to-apples basis. That range for non-GAAP EPS is based on an assumption of about 435 million fully diluted shares outstanding during the quarter compared to a first-quarter average of 483 million and a quarter end of 444 million shares.

For the full year 2006, as we said in the press release, we're comfortable with the current range of analyst estimates for non-GAAP earnings per share. As far as share buybacks, we are about nine months ahead of our original schedule because of the success of the tender offer and we believe that, market conditions permitting, that we will complete the remaining $1.2 billion of share repurchases by the end of fiscal year 2006, one year ahead of our original schedule.

Our tax rate for the year still looks like about 25%. It was pretty tough to tell what our GAAP tax rate was in the first quarter, but it was about 16% on our normal business and we had a very, very low tax rate on the divestitures. But for the remainder of this year we expect the GAAP tax rate to continue around the 16% level, always plus or minus a couple of points. Depreciation for the year is unchanged from our prior guidance of 175 million, the same thing for capital spending, about $200 million as we are funding and building the systems and processes for the new Agilent as well as for STS. You should assume a midyear IPO for semiconductor test systems of less than 20% and a final distribution just before year-end.

Bottom line of all this, even with all the restructuring that's taking place the performance of the business is very good and we would expect free cash flow from operations again this year greater than $600 million. In fact, thinking about cash flow generation and Agilent's operating model from a longer-term perspective, we believe that we have now built a business that is capable of being both earnings and cash flow positive under any but the most extreme economic circumstances.

We have a margin and expense structure now that is very attractive at the 54% gross margin and 12% R&D, 27% SG&A. We also have a variable pay cost structure that helps us modulate throughout the cycle. Because of the variable pay programs we've put in we will automatically gale scale 20% in our compensation costs, 20% variable pay during the really good times when we're making 35% returns on invested capital and 20% operating margins, but then that's scaling down to zero if we hit a 5% operating margin or below. So again, embedding the compensation and rewarding the employees for the good times and for maintaining the discipline during the good times through variable pay.

We also have great asset velocity now which is what allows us to remain free cash flow positive under almost any normal economic circumstances. So what do we think our cyclical model is? You've heard the cycle average -- we do believe that during really good times we could get up to an operating margin of 20% with 56% gross margins, below average operating expenses and a return on invested capital that could be 35% or higher.

And in the trough -- and nobody likes to talk about troughs, but these are still somewhat cyclical businesses even if much less cyclical as the pure play measurement company. But in any case we believe that we will be able to modulate our operating expenses and continue to enjoy gross margins that we didn't see until recent years. And troughing at a 5% operating margin, 8% return on invested capital.

And thinking ahead, assuming that the world economy holds up for the next two to three years, we would expect to be operating considerably above our long-term cyclical average. In fact, let's turn to that now. For example, imagine that we could just snap our fingers, as we said in August 15, and that semiconductor products would be gone, Lumileds would be gone, STS would be spun off into an independent company and we would have completed the reduction in our global infrastructure costs instantaneously.

If we could have done that, and if the global economy in our markets enabled Agilent to see secular growth of our top line, this is the kind of performance that we would expect to see from Agilent over the next couple of years. I'll be clear, this is not guidance, but an example of the kind of performance we would expect to see given the kinds of top-line growth you see here.

This is the new Agilent, electronic measurement has already grown from a $2.7 billion business to $3.4 billion plus this year, 5% average growth over the past four years, accelerating to 9% by 2007. Operating margins have averaged 10% over the past two years as we've gotten increasing momentum and benefits of the massive restructuring program that took place in that segment. This year, 14% operating margins should be expected, and improving again to even better than that, to 16% by '07.

Return on invested capital, the fundamental metric that we measure our success by, as you can see, 17% last year will beat the corporate targets of 21% this year at 24%, and will be edging up towards 30% next year. For bioanalytical measurement, as you can see a very steady growth business, very profitable business; has averaged 9% growth over the past four years, including 2006. And you can see the 13% growth this year from the impact of our new products.

If we go back to sort of secular growth, next year that would be in the 10% range; a business that will have grown by over 50% in four years and continuing to grow roughly 10% per year. This has been a very attractive business, average of 14% operating margins the past two years ought to be at 17% this year and getting up to the magical 20% number by 2007, assuming we achieve that kind of top line and get the full benefits of the acquisitions that Bill was profiling earlier.

Return on invested capital, a very attractive business has been hitting and exceeding our return on invested capital targets; will increase incrementally from 29% last year to 31% this year, and by the way, that includes the impact of our $100 million purchase of the 49% of YAN that we didn't already own, and then will improve further to the mid-30s range by 2007.

So what does the world's premier measurement company look like? On a going forward hypothetical basis, it is a business that has grown by over 6% per year over the past four years, and ought to be accelerating to around 9% next year, given secular growth and the two points of benefit from acquisitions that Bill mentioned earlier. Operating margins, which averaged 11% the last couple of years, will be well above our secular targets this year at 15% versus our 14 targets. And as I mentioned earlier, edging up towards the mid 17s and higher as we get into the mature parts of this business cycle.

Return on invested capital, nearly met our targets last year at 19%; will be handily above our targets this and next year in the mid-20s, getting to the 30% range. What does that mean for cash? As we have emphasized in recent years, we have developed a structure which is cash flow positive from operations under virtually any economic circumstances. And see 2003, we were still working the fundamental restructuring of the Company. Cash from operations minus capital expenditures was negative $369 million; but look at 2004, with $349 million of GAAP earnings we generated $545 million of free cash flow from operations as we continued to get the benefits of working capital improvements and other efficiencies of the place.

Last year 2005 we generated over $700 million of free cash flow from operations despite flat earnings and this year we ought to generate another roughly $700 million of free cash flow from operations. And next year we see the kind of top-line and bottom-line performance that the hypothetical example would give you. We could see another free cash flow from operations above $900 million. Notice that includes the $200 million of CapEx this year going down to a more normal $125 million going forward. Also this includes about $100 million next year for the kind of fold-in acquisitions that Bill was talking about earlier.

You can see the financing activities that we've had ongoing. We will complete -- as I said, market conditions permitting, we're planning on completing the share repurchase program this year, that's $4 billion that you see on 2006. And even in 2007 that's net proceeds where we are assuming essentially that we will buy back enough additional shares to offset options exercises.

You can see the debt that we took on this year to finance the repurchase program. Total change in cash -- roughly cash flow neutral last year and this year. Notice that our cash equivalent balance, which was $2.3 billion in '04, $2.2 billion in '05, roughly $2.3 billion this year despite $4 billion of share repurchases and that balance could be as high as $3 billion or higher at the end of '07. In part because of the continued improvements that we're seeing in our working capital. As you can see, receivables continuing secularly to improve and even more dramatic improvements in inventories.

So what are we going to do with all that cash? Next slide, please. Here are our thoughts about Agilent's capitalization strategy. As we've mentioned, Agilent is now cash flow positive from operations under normal economic circumstances including normal business cycles and our surplus cash may exceed 2 billion this year and 3 billion by next year -- if the world is good to us.

What are our strategic priorities for the use of cash? First of course is to reinvest in the business. We have 12% that we invest in R&D on average over time and we always want to make sure that we are taking care of the business, of the products, of the customers that we have today and staying at the absolute leading-edge in our products. We reinforce that an edge out incrementally with fold-in acquisitions that reinforce and potentially extend the measurement footprint where we are confident we can create 20% return on invested capital on that incremental investment. And Bill mentioned earlier a little profile of some of those acquisitions and the early successes we're having with them.

Next we want to offset dilution from options exercises. You heard me just mention that in our assumptions we should be at least assuming that we would use the cash to offset impact of options exercises. And then finally, to return capital to the owners via share repurchases and/or a dividend. We will, as Bill mentioned, consider larger acquisitions but only if they're synergistic with the business that we have. We are the world's premier measurement company. It's a $40 billion market, and we want to take full advantage of that opportunity as the world's leader.

If we can find larger acquisitions that are synergistic and we're convinced the combination will create significant shareholder value, meaning hitting a 20% return on invested capital by year three for example, then we will consider it, but if we can't generate that kind of return for our owners on the incremental cash we'll give it back to the owners.

Summary -- Agilent had a solid first-quarter performance, meeting our operating, our transactional and our transformational commitments. We executed $3.7 billion of divestitures and we returned $3 billion to the owners. We hit our midcycle operating model even during a seasonally weak quarter. Our second-quarter and fiscal year 2006 guidance reflects the confidence we have around the market momentum we have, the impact of the new products we're introducing, and that we will sustain the operational excellence that we've demonstrated over the past couple of years.

We've built an operating model that should be cash flow positive under normal economic circumstances and we expect to see annual operating free cash flow generation of $600 to $900 million per year over the next couple of years. Market conditions permitting, we will complete the $4.466 billion repurchase program this year, one year early. And we will revisit our capitalization strategy at year end after we've completed that program.

Achieving higher profitable growth is the strategic opportunity for the first time. The truth is we've spent most of the past six years transforming the Company, first trying to survive the horrendous downturn that we suffered, then trying to develop an operating model that could achieve the kind of performance that we're now showing. For the first time we are getting asked by all of you increasingly what are we going to do to leverage and extend the value that we are now creating through this great operating model. We do recognize that higher profitable growth is a great strategic opportunity for the first time.

Lastly, I couldn't help but to point out that the value of Agilent today is both the cash value of the world's premier measurement company and leveraging that over time, plus the value of STS that we'll be spinning out at mid year, plus the value of cash on the balance sheet. With that I think we will turn it back to Hilliard and open it up for questions.

At this time, operator, can you give instructions to the participants on the line for Q&A?

(OPERATOR INSTRUCTIONS).

Operator, we will take the first question from the auditorium and then we'll move to questions from the line.

Excellent. Standing by.

Why don't we go ahead with Ed White from Lehman Brothers?

This year you're expecting to achieve higher growth in market average and bioanalytical measurement, but for electronic measurement it's about in line with the market even though you've done a lot of new product introductions this year. Is the reason why the higher growth for electronic measurement comes in 2007 rather than 2006?

I'm sure that -- this is Bill speaking -- I'm sure when Pat Byrne talks you can also ask him the question in terms of the growth. You're absolutely right, Ed, we have made a lot of investment in the joint venture in China. We've also increased our investment to have a broad line of offerings in our general instrumentation. I know Pat will go into a lot of details of the other growth initiatives and hopefully we're just being conservative. But this year really is getting our new product families in place and to really position ourselves to take market share.

John Harmon, Needham & Co.

My question is drill down a bit into general-purpose. You had nice positive year-over-year orders growth whereas most of your competitors in general-purpose tests are really flat year-over-year. Is there something different that you're doing or are you just really leading the group by virtue of being bigger than your competitors?

I think we have a very strong position and, Hilliard, the best is that Pat's in the room. Why don't I have Pat answer the question very specifically on the progress we've made in general-purpose tests.

Pat is coming up to the stage.

I think given our global position, given the strength of our sales channel, the focus especially in Asia and in Japan in the Asia-Pacific region, that combined strength of our new product introductions, especially in the oscilloscope business, has led to the strength of the general-purpose sales in the last several quarters.

Thank you. At this time we'll take a question from the phone line.

(OPERATOR INSTRUCTIONS). Mr. Terry, at this time there are no questions in the queue.

Okay, we have ample questions here in the auditorium. The next question will come from Darryl Pardi, Merrill Lynch.

Thank you. Adrian, can you just aggregate the factors in your model that get electronic measurement from 11% operating margins in '05 to 15% in '07 and then do a similar exercise for bioanalytical?

Sure. I would tell you that if you look at our first-quarter results in our EMS segment, we are already virtually there. You'll see an 11% operative margin in the first quarter, but first quarter is always our weakest quarter by a considerable margin. So in essence it's getting just a little bit of leverage on the higher growth that we expect in the remainder of the year plus the kind of discipline that we've seen, the 4 point improvement in gross margins year-to-year continuing as we gain momentum through the year.

On bioanalytical solutions, as Chris has emphasized repeatedly, we've been making significant investments in our integrated biological solutions business. It has not been profitable as we've been making those investments, and this is the year that that business turns around and becomes profitable. And that impact alone is worth 3 points in the operating margins of the bioanalytical systems business. And then of course you get the leverage of 13% top-line growth as well. So that's actually fairly conservative incrementals plus the turnaround in the IBS business.

Thank you. The next question will come from Deane Dray of Goldman Sachs.

Thank you. Two questions. The first one is for Pat. Could you provide some additional color on the strength of the scope's market for Agilent? How much of your performance is coming from new product introductions, at what level -- low, medium and high? And how much might be coming from share gains?

Deane, those are really combined, the share gains with the new products because the new products are the things that are gaining the share. So the -- but it is the new products that is driving the growth. The growth rate is more than 10% in the scope business and we're taking market share from the -- by just measuring that revenue growth from the other major players in the oscilloscope business.

and where particularly end markets are strong it looks like aerospace and defense?

I think it's the Aerospace defense industry, it's also the lower cost products that we've introduced which are a very broad set of electronics markets, again, in Asia-Pacific. And then also in some of the supply chain into the -- that is testing, for example, advanced semiconductor devices that go into the IT industry, the computer industry, the wireline equipment industry at the high end.

Great, thank you. And then the second question would before Adrian. You provided some additional color on the geographic performance in the quarter. You said America's orders up 6%; Asia, did I hear correctly at 35%? Just provide some additional color what was driving that.

Yes, you did hear correctly, 35% year-to-year, and Pat was alluding to some of that. We have been really focusing on Asia in both segments of the business whether it's the low-cost instrumentation that's gaining so much momentum in the Chinese and Asian markets or the strength of the bioanalytical systems because of the infrastructure -- the just huge infrastructure requirements and demand in China and India and in both of those areas are orders and revenues are up strong double-digits.

So it really is secular demand as those world economies are beginning to become developed economies and have 200 million population of middle-class citizens that are existing on better food quality, air quality, water quality and as well generics. The demand for generic pharmaceuticals -- or from generic pharmaceuticals is very strong. Again, in India our demand is up very strong as I'm sure Chris will emphasize later.

Thank you, Adrian. The next question will come from Richard Chu of SG&A Cowen.

Thank you. Adrian, I've got a couple questions. First of all, on the continuing operations operating expenses for the quarter, about $540 million, that looks like it is up sequentially from Q4 if my arithmetic is correct. Could you comment on that? Anything we should understand?

Richard, if you look at page 3 of my presentation you'll see that R&D is up 3 million, but SG&A is down 3 million. So I think we're flat sequentially.

Okay. Why should that not be farther down given the seasonal declines if you're looking Q4 to Q1?

Our structure doesn't flex quite that much that it's going to adjust for a seasonal pop. We also will have variances in our cost structure because the beginning of the year you have wage increases, you have FICA, you have other costs that happen at the beginning of the year, whereas in the fourth quarter many of those compensation costs have hit their limits. So it's essentially seasonal. And I would really focus on the 2.5% increase year-to-year in operating costs in the face of a 10% increase in revenues as being more indicative of the kind of discipline.

But I'd also remind you of one other thing and this is, if you will, the negative side of putting a variable cost structure in. The variable pay that is being accrued in the first quarter of this year will be significantly higher than it was a quarter ago because we hit our 21% return on invested capital and that's the target for 10% variable pay versus last year at this time with a 10% return on invested capital, the variable pay was down in the 5% range.

That's helpful. If I can pursue the question of the global infrastructure [reduction], you said earlier that you expect to be at your target level by the middle of the fiscal year. So let's assume that's -- that's the end of Q2. In thinking about Q2 versus Q1 cost structures, does that mean that your fixed cause structure somehow will be better sequentially (multiple speakers) in improvement?

In fact it will be, Richard, because we are continuing rapidly to get headcount out to consolidate sites. But what we're also -- you have to remember is that during the fourth quarter and the first quarter we were providing a lot of services to Semiconductor Products through that same global infrastructure and that was offsetting some of that overhang that we otherwise would have recognized. In the first quarter in fact we were able to absorb 100% of that overhang because of having the extra month of semiconductor products in the business because they didn't complete the divestiture until December 1 rather than the original intention of November 1.

So we had a windfall from an extra month of providing services to Avago in the second two months of the quarter we did have a little bit of an overhang, but on balance we were able to absorb it. And the really good news is that we believe we've made enough progress that we will have essentially -- be able to essentially absorb it again in the second quarter.

So net net it should be flattish is what you're saying?

Other than the normal seasonal increase in expenses for things like tradeshows, etc., yes, we would expect to see a continued secular decline in our global infrastructure costs through the remainder of this year and into early 2007.

Okay, thank you.

Operator, do we have any questions on the line?

Yes, sir. We have a question from Richard Eastman from Robert W. Baird.

Just a question regarding the electronic measurement business. Can you add some color to the two segments? The wireless segment obviously strengthened in the quarter and I know we've been working through some backlogs there at least on the handset side. But can you give us a sense of how you expect those two pieces of the business, the wireless and the wireline, to play out for the balance of the year and consolidate into your 5% growth expectation?

Pat, why don't you go ahead and answer that?

The wireless business is really driven by two major factors. The first one is continued growth in the cell phone testing business. The cell phone testing business is driven by three major factors -- capacity expansion, share shifts and new technologies. And so last year was a strong year of cell phone growth, 800 million phones shipped last year. So I would expect that this year will be another strong year of cell phone testers. We had a strong quarter in Q1.

The second major factor driving the wireless market is the new technologies that are coming online this year related to 3G and 3G plus. We have strategically, and I'll be covering this a little bit later, started to focus more on R&D solutions. It's a large market, good gross margins and so we should continue to see growth there as well. So that I would expect to be one of the main growth drivers for the communications test business. It's the largest part and should see strong growth throughout the year.

Wireline is sort of in a pause. Some of our top customers have put limits on their capital spending. I would expect that to recover moving forward but not to be as high a growth as the wireless test business.

And were you able to build some backlog in OSS in the quarter? Were the orders stronger than the sales there?

We'll let -- Tom will answer that question.

Backlog in OSS, we did build backlog then from Q1 to Q2 primarily because of some of the acceptance delays that Adrian and Bill alluded to earlier in the presentation.

Very good, thank you.

Operator, is there another question from the phone line?

No, sir. At this time there are no questions in the queue.

Okay. We'll go back to the auditorium. Ajit Pai from Thomas Weisel.

The first question is for Adrian. Adrian, at the end of your October quarter you had about 1.37 billion that you took as a tax valuation allowance. Once you've -- have any of those been lost when you divested SPG? And over the next couple of years, what first percentage of that do you expect to use up and will be accretive to cash flows?

Ajit, a very good question. Part of the reason why we had essentially on a GAAP basis no taxes on those divestitures, and part of the strategic reason for doing divestitures in the first-place rather than spin-offs was because of our tax loss carry forwards and we did consume a bit of them. The tax basis of SPG was about $1 billion, so we did consume some of the deferred tax assets that are no longer on our books. We believe that with the state of the business and the fundamental turnaround that we've seen in the operating structure of the U.S.-based businesses that we will be consistently profitable and increasingly so going forward.

Our best guess is that it will take another roughly two to four years to totally absorb the remaining deferred tax assets and at some point, perhaps in a year or so, PWC will come to us and say, hey, put those deferred tax assets back on the books. And so we'll get another giant gain just like we took a giant loss a couple years ago. But for the moment that's the reason why for a pro forma basis we say we have a 25% tax rate, which we're very proud of, but on a GAAP basis we have something like a 16% tax rate and the entire difference is the fact that in essence anything we earn in the U.S. is tax-free for at least the next three to four years.

Right. Second question is on your electronic test business. I think I just heard back and just talk about the mix between wireless and wireline. But the wireline spending after about four years of decline has been coming back and a number of Test and Measurement players in that space have been showing some rapid growth. Is it that your quality of portfolio of your exposure to wireline tests, you still have exposure to wireline, what percentage of your electronic test business today is wireline? And why are you not as optimistic growth rate as the growth rates some of your peers are showing right now in that space?

I'll take first shot at that that and then I guess I would turn it over to Pat as well. I would say we are probably being deliberately conservative. Perhaps it's been down for so long and then you see a little bit of an interruption because, as Pat said, some of our major customers have clearly put capital spending freezes on as the adjust their structures. And some of the major service providers are also going through consolidations and are really clamping down at the moment on CapEx.

But I would agree that we could be being a bit conservative about wireline. It is about one-third of our communications tests which is about two-thirds of the EMS segment. So that's the size of total wireline these days including OSS. It's a much, much smaller business than it used to be.

Thank you.

Any additional comments?

Just one additional comment. That the split wireless to wireline is, as per Adrian's comment, I think that's on the instrumentation side of the business -- on the OSS side of the business. But we are seeing a resurgence of expenditure from the operators particularly as triple play is starting to kick in. Obviously a lot of the triple play that you hear about right now is at pilot stage, but those pilots are growing. So I think there's a certain amount of optimism around the test requirements and the OSS requirements as triple play (indiscernible) quad play over the next one to five years.

Are there more questions for the audience before we circle back to Deane? I can't see that far back, but please state your name and company name also.

David Wagstaff from HSBC. A question for Adrian. Given the new order momentum in Asia of about 35%, will they require any supply chain adjustments in order to optimize the business delivery in the region and will that have any knock on effects on working capital management initiatives?

No, we have done I think a pretty darn good job of keeping our operating facilities close to the customers. We have order of magnitude 60% of total Agilent production facilities today in Asia. So obviously we need to be able to quickly flexibly expand capacity as appropriate. But we feel pretty good that we have the supply chain that's in very good order, particularly out of Malaysia and increasingly in China, to serve that rising Asian demand.

Okay, Deane?

Thank you. Adrian, just to come back to your comment that you would be revisiting your capital structure at the end of fiscal '06, at this stage, at this run rate what would you expect the net cash per share to end up in fiscal '06? And then give us a sense of what your options are in terms of the use of cash, additional buybacks and how are you thinking about a dividend at this stage?

Sure. I think if you take a look at that slide 15, I believe, it showed that we had something like $2.3 billion of, if you will, surplus cash -- debt free cash on the balance sheet, or roughly something like $5.50 per share and obviously that goes up a bunch in 2007. I think our priorities for what we do with it are on slide 16, I believe, that we went over earlier which is, again, we want to continue to do the kind of fold-in acquisitions that on the margin are easy to fold into the business to run through our great sales channel that reinforce and extend our capability in the measurement arena. And where we are quite confident that we've been able to demonstrate that we do generate 20% returns on that incremental investment.

Next is to offset the dilution from options exercises. And then I think we will be talking about either additional share repurchase programs and/or a dividend. And Bill probably wants to jump in here, but we've been clear that when we have the confidence that this really is an enduring cash flow positive company that we are clearly gaining and when all of these transactions are over, including the share repurchases, then we're obliged to view how best to return that capital to the owners.

We've been very consistent on the three options, as Adrian has outlined, and we will continue to work with the Board of Directors to come up with the best decision, we believe, for our owners.

Thank you, Bill. Operator, I'll go back to the lines and check to see if there are any questions on the phones.

(OPERATOR INSTRUCTIONS). At this time the queue is clear.

At this time we'll go back to Richard Chu of SG Cowen.

Thank you. Bill, in one of your national slides you talked about your goal being to increase gross by 3 points through M&A. And then you talked about the fact that you have already added a couple points perspectively from what you have done. Does the illustrated picture for '06-'07 include fully the -- those 3 points or is that somehow in addition to what you have laid out for us?

Richard, just to make clear, that's the targeted growth these acquisitions are 2 points. So in other words, we had made these six acquisitions over the last five quarters. And of course to justify it, in addition to having a greater than 20% return on invested capital in year three is the growth numbers putting in. so if you look at this overall market growth of which Adrian went through, we're targeting to have 3 points additional growth inside of that M&A. And so we're going to have sort of a cascading effect, but we will continue to look for acquisition opportunities as we move forward. And typically the growth number that we would get is in that year three.

Okay. And then unrelated to that, Adrian, can you help us understand how the -- assuming that you don't make any share purchases in Q2, how we should think about the other income line which is roughly $40 million in Q1? Are there major currents that we should be conscious of as we look at that?

No, you can see the cash and please look at both the restricted cash and the cash and short-term investments line when you're thinking about what are we multiplying the interest rate against. But this is all invested in short-term very marketable securities and nothing exotic. And I think if you were to assume -- I don't think it's the correct assumption, but if you were to assume that we didn't do any share repurchases in the second quarter, then you ought to assume that we would be cash flow positive in the quarter and that would add to the cash balance that we have at the end of the first quarter.

Okay. There are no other meaningful non operating items or disappearance of gains, etc., that will affect that?

No. Again, into the first quarter we had $2.7 billion of cash and equivalents and we had $1.6 billion of restricted cash. And of course, we would also pay interest at about LIBOR plus 50 on the long-term debt, 1.5 billion -- but that would be the basis. And the second quarter is traditionally fairly significantly cash flow positive. I think you can add a little bit to there.

Thank you.

Next question will come from Ed White of Lehman Brothers.

Adrian, just a small question on guidance looking forward. How would you expect the equity based compensation expense to go through the year? I know it was $0.07 in the first quarter and you talked about $0.18 for the year, but would you expect it to be pretty evenly distributed the rest of the quarters or might it be a different pattern from that?

$0.04 to $0.05 per quarter and slightly lower towards the end of the year.

We'll go back to Ajit Pai.

Adrian, what is the share count at the end of the quarter on a fully diluted basis?

444.

Operator, I'll go back to the phone line. Are there any questions from the phone line?

At this time, sir, there are no questions in the queue.

We'll go to Jack [Murphy]. They won't be able to hear you on the line, Jack.

Two questions. One, are you guys willing to lever the balance sheet at all while you take on net debt as opposed to net cash being a more predictable company going forward?

I'll begin that and I'm sure Bill can jump in too. At least theoretically we now have a company that is cash flow positive during normal economic circumstances. And so modern capital theory would argue that we ought to have a little bit of net debt on the balance sheet. I cannot argue with that. We're just so far away from that right now that it just seems pretty hypothetical. And right now we're trying to make sure we understand what the options are for getting the surplus cash back to the owners.

But Adrian and his team have done a good job of evaluating other companies that have similar business models. We continue, as I mentioned before on a previous question -- continue to work with the Board to make sure that this full agreement on what our whole structure is and what's the best way for us to return value to our shareholders.

I've got a couple more. And I think in the last year you were paid most -- or some of your variable comp was based on an ROIC calculation and you obviously did well there. Are you going to change the metric to include top-line growth anytime in the future?

Right now our focus is still continuing to be 100% of return on invested capital and, as you know, the growth is a big component on that. But we have worked so hard to get a very strong operating model that we want to make sure that it is absolutely built into our DNA that we will return greater than 20% return on invested capital. And as you probably know, many studies have been done; companies that consistently return greater than the cost of capital, their stock outperforms their competitors and the market.

Okay. And the last questions I had were when you look at your theoretical '07 over '06 forecast -- the income statement forecast, incremental margins in the test and measurement, they've been about 40% and incremental margins in the Life Sciences businesses are about 44 to 45% I think. Are those metrics we should use going forward if you exceed or fall short of your top-line growth by X?

Yes, those are pretty good incremental decrementals. Earlier on in the cycle as we were getting the full benefits of the transformation and higher volumes, we were talking about the need to get 60 to 65% incrementals if we were going to achieve that operating model. Well, we're there. And on the increment now, especially with the variable pay kicking in as well, I think that something in the 40% range for the continuing business is about the right kind of incremental decremental. Do remember that if we add acquisitions perhaps in the first year that will affect the incremental one way or the other. But yes, that's a pretty good guess.

Thank you.

Thank you. Are there additional questions here in the auditorium? Back to John Harmon.

Thank you. I was just curious what your general attitude is regarding large acquisitions? You gave us the financial hurdles, but there are a couple obvious candidates in the electronic measurement, five that would be a good strategic fit and several on the bioanalytical side. Are these things you're more likely to look at? It seems more things are on the table these days with Agilent than there used to be.

Sure. We do internally through the Company, through our corporate development organization working with the businesses, have a very robust process of evaluating all alternatives. And so we will not shy away from making a large acquisition that we think is in the benefit of our shareholders, 70% of these large acquisitions fail. We're very much aware of that, but we do have the process, we do have the analysis and have our lookout for synergistic opportunities as they may arise.

And I think one of the things you can have more confidence about today than perhaps in the past is that through all of this work in transforming the Company we have built a capability to do the kind of consolidation and integration of acquisitions that really does eliminate duplicative costs, really does leverage the strengths of what you're buying, but put it into a system and a channel that in eliminating costs that really can create the kind of cost synergies that all of those studies will show are the source of the value creation.

Are there any more questions in the auditorium? Operator, are there additional questions on the line?

At this time there are no questions in the queue.

Okay, we are at a point where we can actually break at this point. Let me just stop and review the agenda for the rest of the morning. We are going to shorten the break given that we have people on the line to 15 minutes instead of half an hour. We will reconvene at 10 AM in about 15 minutes after which Chris van Ingen, President of our Bioanalytical Measurement business, will present. After that, Tom White -- I'm sorry, Pat Byrne in Electronic Measurement, and then Tom White of the operations support business and then lastly Bill Sullivan, our CEO, will come back with closing thoughts. Thank you and I will see you in 15 minutes.

(BREAK IN PROGRESS)

Can I check to see if the operator is back on line?

Yes, sir, we're back into the main conference on an open line.

Okay, thank you. Thank you for joining us again. Again, this is Hilliard Terry, Director of Investor Relations for Agilent Technologies. We are going to resume our 2006 analyst meeting at this time. But before we move to the next speaker, I would like to just bring Adrian Dillon back on the line. During the break we had a couple of questions just about the cash flow and wanted to do some clarifications in terms of if you're doing the math here in the room how the restructuring is included in the asset sales. So Adrian, if you are on the line?

Hilliard, can you hear me?

Yes, I can hear you now.

My understanding is there were a couple of questions about the mechanics of the cash flow. So let me start by going to page 15. I don't know if you can put that up or not. But let me emphasize that the cash flows suggest that cash from operations -- and that includes all of the restructuring costs -- would be roughly $900 million. And then subtract out the $200 million of capital spending, you'd have net free cash flow from operations of about $711 million, not that we're trying to be that precise.

We would be recognizing the costs of the restructuring in the operating cash flow items. The offset in the property sales would show up down below in investing activities in the other including restricted cash. Notice that that is not $1.6 billion which is the restricted cash, it's $1.86 billion, so that's where we are reflecting the gains from the sales of the businesses as we restructure GIO. In fact, the $700 million is if anything a downward bias measure of our free cash flow generation this year. And then obviously on a normalized basis when we're through all of these transformations, that free cash flow goes up to close to $1 billion by 2007. Does that answer people's questions?

Yes, Adrian, thank you. Just wanted to make sure for the benefit of the people on the phone that everyone was able to hear the response to some of the questions that we're getting here in the auditory. So thank you again. At this time I'd like to introduce Chris van Ingen who is President of our Life Sciences and Chemical Analysis business. Chris, are you on the line?

Yes, I am.

Okay, Chris. We're ready to go. Thank you.

Thank you, Hilliard, and good morning, everyone. I wish I could be there in person, but unfortunately due to whether we were not able to do that. Hopefully what I will do today is really talk about the bioanalytical measurement sector, I'll talk about the addressable markets. I'll cover our business portfolio, talk about the growth drivers for the business and then spend most of my time on the key growth initiatives for the bioanalytical measurement sector and then close with an overview of a very (indiscernible) new product launch you will see in 2006.

So looking at the bioanalytical measurement sector, as you've most probably heard from Bill and Adrian, about 20 billion of the total $40 billion opportunity for Agilent is in the bioanalytical measurement sector. In this sector the market is comprised of four major platforms, as you can see at the bottom of this slide. In terms of separation techniques, in spectroscopy both in organic and inorganic spectroscopy, and then a major portion of the overall market in terms of life sciences tools.

If you break the $20 billion market into pieces there is the Chemical Analysis business which is a total -- total size of that segment is about $6 billion with a CAGR of about 5%. And then the Life Sciences business which is the majority of the $20 billion is about 14 billion with a CAGR of about 9%. As you can see from the graphic over here, the breakdown in the distribution of these platforms across these two markets is different.

A key point I wanted to make here though is that there is a lot of Cinergy and leverage particularly in the separations and organic spectroscopy area which includes -- the latter includes mass spectrometry NMR and those techniques across both segments. Bottom-line though, there's a lot of opportunity for organic growth as well as M&A opportunities, as you heard from Bill and Adrian.

Next slide, please. So here is the portfolio we're managing on an LSCA level. Basically two businesses, the Chemical Analysis business which is about 58% of our revenue, and then the Life Sciences business which is about 42%. The Chemical Analysis we serve a number of sub segments from (indiscernible) chemical all the way up to forensics and Homeland Security, in our Pharma analysis business, also I think a really good term for this would be the small molecule analysis focused on drug discovery, drug development and manufacturing AQ/QC. And in those two segments, Pharma and Chemical Analysis, we are the market leaders. And I think our focus, as you will see when I talk about the growth initiatives, will really be to continue to extend our market leadership through a set of innovative products and services.

And then the second part of the Life Sciences portfolio is integrated biology focused on disease and drug discovery, particularly focused for Agilent on a rate-based genomics, and more importantly on LC/MS-based proteomics and in a very logical extension of the proteomics business and the evolution in integrated biology is to focus on metabolomics. And then lastly I will also cover our entry into the diagnostics market -- particularly the clinical diagnostics market. So the key focus here, as you heard, in terms of investments is to continue to accelerate the top-line growth overall from an LSCA perspective.

Next slide, please. So here are the growth drivers for both the Chemical Analysis and the life sciences market. From a Chemical Analysis perspective, a very important point nowadays are regulations in the environmental and food testing markets. As the world focus for this business has shifted from Western Europe and North America to Asia-Pacific, very significant growth drivers in Asia, but also in actually Eastern Europe.

A very important point for us continues to be the GDP growth in China, in India as well as Eastern Europe, particularly Eastern Europe the former East Block countries, their major investments in infrastructure improvements and there is a need for Chemical Analysis equipment. We see a lot of customers in the Chemical Analysis business due to the fact that there are less skilled operators, there's more and more demand for automation and better informatics.

And lastly in this business there is a huge installed base, certainly across all of the sub segments I showed you, so major opportunities in terms of the after markets, in terms of services and consumables, and then also the replacement cycles. I think a good example has been the -- certainly the improved profitability in the petro chemical industry has really led to faster replacements of major system installations for gas chromatography and mass spectrometry.

In terms of life sciences, although the R&D spending in the public sector in Pharma has decreased compared to previous years, the increase in spending has decreased, I think there's still a very healthy market where we see very significant investments in R&D, particularly in the biotech area. And we expect that to continue for the next two to three years.

The emergence of new applications in the industry for Pharma to be more effective across the whole Pharma value chain continues to be an important one, so things like biomarkers, predictive toxicology, Pharma proteomics actually and better focus on the clinical trials improve the efficiency, and then lastly the focus on diagnostics. So those are key drivers for growth as we go through the next three to five years.

And then lastly, very important in this segment in Life Sciences continues to be the regulatory compliance. Certainly true in drug development and in AQ/QC. And that drives a lot of fundamentally key compliance services for instrumentation as well as for information storage.

And then lastly, very analogous to the Chemical Analysis business an increasing demand for more automation and informatics in this industry. Across virtually all of the application spaces customers really would like to spend their time developing drugs instead of becoming experts in our instrumentation.

Next slide, please. So why do we (indiscernible) today? In the Chemical Analysis and pharmaceutical analysis markets we are the leaders. We have the broadest offering of innovative and reliable products. We also have a rapidly evolving portfolio of Life Sciences solutions in the genomics, proteomics and metabolomics space entering into the diagnostics space. We also have deep customer relationships in all of our targeted segments as the leader, really focused on building those relationships in all of the geographies we conduct our business. And then our network of global sales and support channels with the focus on customer service and support.

And more importantly, we are the leader -- the undisputed leader in customer satisfaction and loyalty across all of our markets. And I think the latter point is a very important one. I think it really generates a lot of repeat business for us as we continue to satisfy our customer base.

Next slide, please. Here is our segment operating performance. I won't belabor all of the numbers. I think Adrian went through this in good detail. I think a few key points I would like to make is that these financial results include the integration of three acquisitions. And more importantly, I think key platform rolls -- last year we renewed the GC/MS platform; this year, as you will see in a few minutes, we are fundamentally replacing our flagship 1100 liquid chromatograph with the new 1200 series. And then our significantly expanding and upgrading our LC/MS portfolio.

We also have industry-leading receivables, inventory and return on invested capital performance and then, more importantly, I think as you heard, as we move forward and look at our operating model for the next two to three years, one of our key goals has been to bring the -- our rate based genomics and LC/MS based proteomics business -- make that profitable by the end of fiscal year '06 which will have a fairly significant impact of almost 3 points on our operating margin percent.

Next slide, please. So what are the key growth initiatives for LSCA moving forward? And you can actually break that down into four major initiatives. One focused on our core platforms like liquid chromatography, ICPMS, LC and LC/MS and our goal is to continue to refresh these platforms as we go on. As I indicated before we fundamentally refreshed our GC/MS platform last year, are refreshing our LC platform this year and have plans for GC and ICPMS platform in the next 12 to 18 months. The key focus on continue to expanding the workflow automation that means trying to provide better solution across everything a customer does in the lab and also capturing more wallet share of that workflow. And then to focus not only on China, is to build the market leadership in China and India but also with the buyout of the minority share in Japan, I think we have a major opportunity to increase our market share in the Japanese market with our core platform portfolio.

Second major initiative is on the aftermarket. We currently have leadership in our gas chromatography consumables and supplies and don't have that same position in liquid chromatography column. So one of the key areas of focus is to achieve the leadership in LC columns business and consumables and that certainly will be a combination of what I believe organic growth and an opportunity to explore M&A in that area.

And then lastly, to continue to expand our lab wide services portfolio. We do have a lot of product specific services here in this area. We're looking at things which we can layer on top of all our products and fundamentally are focused on the operational excellence of customers in the laboratory. So things from lab resource management to integrated multi-vendor compliance and multi-vendor repair will help things in the scope of the aftermarket portfolio. And again, our aftermarket revenues are about 38% of the total revenue, so a very key point for us to continue to focus on that and make sure that we continue to grow this business.

Laboratory informatics, as you heard from Bill earlier, we did two acquisitions this year -- Scientific Software and also Silicon Genetics. That really those two companies have provided us the network and the capabilities we need to fundamentally have a complete solution for customers all the way from Chemical Analysis to Pharma Analysis as well as in the Life Sciences space. Our goals over the next -- growth initiatives is to continue to converge the software platforms, have less platforms available.

Ultimately our goal in the next 12 to 18 months is to go to three platforms, one for chromatograph, one for mass spec and one for laboratory-on-a-chip so we don't have to -- we can really focus on expanding -- not spending all of our resources on platform development, but basically doing what I think the second point here mentions is to continue to expand our software applications portfolio because that fundamentally today really determines the performance of an instrument. And then lastly, continue to expand the informatics portfolio, things like electronic (indiscernible) management, lab notebook and then also our reentry into the lens business.

And the fourth initiative is focused on Life Sciences. Continue to expand our rate-based genomics portfolio, expand our mass spec based proteomics and metabolomics portfolio and then also to continue to expand our lab-on-a-chip portfolio into the diagnostics market. And in this slide here you see an example. Our goal really has been to leverage the key technologies we use in the research phase in Life Sciences, also into the $30 billion diagnostics market.

Focus has been on microfluidics and microarrays and also our chip LC technology. A key focus for us in the diagnostics space is on chronic diseases requiring ongoing testing. And then really just very interesting in the less 12 months, we've been able to fundamentally develop the first product on a microfluidics platforms and it's focused on co-cholesterol-lowering drugs. It's a lipid chip product, it can do HDL and LDL subtractions.

And as you can see on the bottom, we've been able to fundamentally do the separations and get a very stable product out. It is currently -- will be a home brew application in the diagnostics business. And as we go through the year we will file for basically FDA approval. So far reception of customers who have been exposed to it has been very, very positive. So again, an example of how we will continue to leverage our key investments we've made in the research space, also into the diagnostics market.

Next slide, please. So here's sort of a summary of the key new products we are introducing in 2006; it's actually one of the largest new product introductions we've seen in the last eight or nine years. Starting on the look left-hand side, as I indicated, we'll have a new liquid chromatograph, it will be the 1200 series LC. It will fundamentally displace the 1100, but also adding new capabilities to the platform. We expanded -- significantly expanded our HPLC chip portfolio. We added another additional five applications. And as we go through the year we will continue to expand that portfolio by focusing in on work flow solutions and, again, these chips can be used with all of the mass specs you see on the right hand side.

We basically are expanding our mass spec portfolio. There will be a new LC/MSD which is sort of a single quad to the low-end mass spec in the mass spec used for LC detection. We have a significantly enhanced version of our [hand trap], a significantly enhanced version of our time of flight. But more importantly for the first time I think we basically are adding two new LC/MS platforms which are very important for the high-end in this business. The new triple quad and our new Q-TOF. So we're very excited about it; I think it fundamentally doubles the addressable market for us. And our goal in the next two to three years is to fundamentally double our market share in the LC/MS market.

The last point I wanted to make is the new products in terms of contribution to our revenue. I think it's been about 12% and as we continue to roll out these new platforms that percentage is projected to go up to over 20% by fiscal year '06.

Next slide, please. So in summary, how do we measure our success? I think we have a solid foundation in the chemical analysis and in the life sciences business. We're leaders in Chemical Analysis, we're leaders in part of the Life Sciences portfolio. We're rapidly expanding the second part of the portfolio, particularly in disease and drug discovery with leadership and customer satisfaction and loyalty and a very strong new product portfolio as we go through the year and, as you heard from Adrian as well, consistent strong financial performance. With that I'd like to turn it back to Hilliard for Q&A.

Thank you very much, Chris. Operator, at this time can you give instructions to the people on line for Q&A?

(OPERATOR INSTRUCTIONS). Sir, at this time there are no questions in the queue.

Okay, thank you. The first question is going to come from the [Bart Simpson].

First, could you give us a little more detail on the $12 million increase in operating expenses and whether they are -- of what degree they are recurring and nonrecurring in nature?

Yes, I think looking at the expenses, as you heard from Adrian, we've made some fairly significant investments particularly in the LC/MS portfolio. We felt that it was important that we are fundamentally participating in the high-end of the market so the triple and the Q-TOF. Those expenses -- I mean operating expenses will start to taper off as we roll out the products. My expectation is that it's in the third quarter of this year. But that's a non-recurring expense.

I think suddenly, the three acquisitions we made last year are fundamentally adding to the expense base and -- but the goal here is to really just get the leverage on the top line, as you heard from Bill, as to fundamentally see more growth as we go through the year. I think Adrian showed you that fundamentally our projected growth toward the end of the year is significantly higher than what we saw in the first quarter. So part of it is -- I would say almost 50% of it is nonrecurring.

Thank you, Chris. The next question will come from Darryl Pardi, Merrill Lynch.

Can you discuss how Agilent views its position in the diagnostics market? Are you a provider of tools that third parties will develop tests on or could Agilent be developing diagnostic IP as well?

Well, we potentially could do that. Right now looking at the first product, Darryl, the HDL and LDL application, it fundamentally is a home brew application, that means it's not fully FDA approved, but it will be used by testing laboratories and mostly in clinical trials in the beginning. As we go through the year we're actively involved in doing the clinical trials for the product itself and believe that we can fundamentally get approval, assuming everything goes right, towards the end of the year. So our goal is to leverage the platforms, find channels our customers which are large users and not build up that whole infrastructure ourselves.

Thank you. Just one follow up. The IBS business, the goal has been for several years to get that business to profitability. What gives you confidence that fiscal '06 is the year that happens?

What gives me confidence are two things. First and foremost is the new array-based portfolio. I think comparative genomic hybridization and location analysis. We're really starting to get the volume there. Secondly, we are in the midst of implementing a whole new manufacturing process which will give us the build and gross margins we need, but as we ramp the volume I think that business -- that part of the business will be profitable.

For our LC/MS base -- the high-end LC/MS, I mean it's simply a matter of getting the products to market, finish the development and then scale the operating expenses back to a normal level. So those are the two key drivers, Darryl.

Thank you, Chris. The next question will come from Deane Dray of Goldman Sachs.

Good morning, Chris. (multiple speakers) first. What was the motivation behind buying out the Yokogawa joint venture position?

There were actually three reasons, Deane. First and foremost, we formed a joint venture about 12 to 13 years ago. Key objectives were to get a profitable business -- product business in Japan which we did for ICPMS. We used that local presence in Japan to fundamentally build a global business for ICPMS and we currently are the leaders worldwide in ICPMS so that objective we achieved. The second one was to get a presence in the Japanese market.

But as we went over the years what we saw is that our channels became less and less effective. We have a set of legacy channels and we believe that by fundamentally changing the mix of the channels go more direct that we should be able to double our market share in Japan in the next three to five years. So it's volume related, it's channel related and basically I think simplification of the organization.

So when you say you're going direct, that will be under the Agilent name and not the Yokogawa, is that correct?

That is correct, Deane. So fundamentally today we are about 70% indirect and 30% direct. I expect that to fundamentally be 80% direct and 20% indirect in the next three years.

Good. And then a follow-up. In previous presentations you talked about Homeland Security as being one of the market drivers for Agilent. I don't think you mentioned it in today's remarks. Where does that stand today and what kind of opportunity?

I think overall we've seen some good quarters from it, Deane, particularly in the area -- in Homeland Security or in forensics. I think that food safety are very strong linked. I don't think that it has ever materialized to the level where we thought it would be. As you will hear from Bill, it certainly is an opportunity for Agilent more holistically if you look at Homeland Security and can we expand the portfolio. So far it's been a leverage play for us in terms of chromatography and mass spectrometry.

Thanks. And just last question. Did I hear correctly that you said a goal is to double your market share in mass spec? And if that's true, what is your market share today?

I think if you look at the LC/MS I can provide you that off-line. It depends on whether you're talking about GC/MS or LC/MS. In the LC/MS business we're currently number four in the industry and our goal is to get to number two in the next three years using the portfolio of the triple, the Q-TOF and then the enhanced lower end of the portfolio as well.

Let me pause again just to check to see if there are any questions on the line.

At this time, sir, there are no questions in the queue.

Okay. If not we will move to Ed White of Lehman Brothers.

Chris, if you look at the bioanalytical measurement market and look at organic spectroscopy overall, as you pointed out, big opportunities in both Chemical Analysis and Life Sciences. And I see where you're expanding in the mass spec part of organic spectroscopy. But can you talk a little bit more about that (technical difficulty)? Are there other non mass spec techniques that might be interesting within organic spectroscopy and would you view that as an opportunity to expand into at some point down the road?

Very good question. I think if you talk about organic spectroscopy there are three major techniques in there. One is mass spectrometry, the other one is NMR, the third one is infrared, IR. Those three most probably make up about -- over 80% of the organic spectroscopy market. Mass spectrometry is very important because it can be used with a separations technique.

So in fact you could take gas chromatography or liquid chromatography and have a hyphenated technique with mass spectrometry. And it's still one of the preferred tools in the industry for identifying structures or confirming existing structures. But we certainly would entertain other things because NMR and infrared are used for structure elucidation and certainly are a key part of the portfolio analytical chemists and biochemists are using on a daily basis.

Next question will come from Richard Chu of SG Cowen.

Adrian earlier I think alluded to the possibility that shipments might have been impacted by the late (multiple speakers) product launches. Could you quantify that?

I think that while Adrian talked about the footprint for Agilent over all, if you look at the footprint of LSCA, I think I have a much more -- I have a different footprint than, for example, in the electronic measurement sector. I think we have still a very balanced portfolio in terms of presence in the Americas, presence in Europe and presence in Asia. And secondly, I think the total volume for us in Asia is lower, significantly lower than it is for EMS. So the impact of Asia on my business was relatively small. It may have been $2 or $3 million in terms of revenue.

Yes, but I wander whether the launch of your new LC/MS technologies along with new products at the end of the quarter might have held back demand during the January quarter?

We saw very strong demand throughout November and December. In January certainly there may have been a little bit of an impact. Although for the liquid chromatograph, Richard, I don't believe that is an issue. If customers are ordering an 1100 they will automatically get a 1200 LC. So I don't think there's any hold back there. In terms of LC/MS, the fact that we announced these new products, it's two market segments we currently are not even present in. So fundamentally we're taking orders from a market segment we've never participated in. That's true for the triple and for the Q-TOF. So it would only be incremental business for us.

What is the delivery schedule at this point for the new products?

The new 1200 is basically where the manufacturing process should be completed by the end of February, most probably the first week of March. So as we go through the quarter we'll switch from the 1100 liquid chromatograph to the 1200 LC. The triple and the Q-TOF are later in the third quarter, the beginning of the fourth quarter.

Thank you.

The next question will come from Jack Chung, (indiscernible) Management.

To the extent this quarter that you -- if I have my numbers correct you spent 10% on R&D for the bioanalytical sector. To the extent that you expect to launch new products aggressively here in the sector and specifically in mass spec, should we expect an increase in R&D going forward?

No, I think as we move forward I think the ideal operating model for LSCA is R&D as a percent of revenue our sales are probably around 9%.

We will take the last question for this part from Ajit Pai.

A couple of questions, Chris. The first one is about a year ago you had given us the breakdown of the overall business and since then you've had some acquisition activities. I think it was a 60, 30, 10 breakdown between Chemical Analyst, Pharma Analysis and integrated biology. Could you give us a breakdown now?

Actually I think I partly gave it. Chemical Analysis is about 58% of the business and then Life Sciences is about 42. If you put the 42, about 28 of that is Pharma and the other 14 is integrated biology.

And the integrated biology systems, the margins in that business currently -- I know you mentioned that you expected to be profitable by the end of the year. Could you give us some indication as to where the margins are currently on the operating line?

I don't think I'm divulging that information, Ajit.

Okay. And then moving on to talking about environmental and food regulations being a driver for the overall business. Could you give us some color if you have any exposure to water quality and whether you see that as a significant driver over the next three years?

Well, water quality is a key issue particularly in Asia-Pacific, we see that in China, we see that in India, we see that in a lot of emerging countries. But there is a -- fundamentally a focus on the toolsets we have had for quite a while and used in Western Europe and North America. So we're leveraging a lot of the work we did many years ago in these parts of the world, particularly in Asia-Pacific.

So it's good business. I think the best way -- when you look at China, the Chinese government is really just investing in some strategic initiatives and they come in waves like traditional Chinese medicine, environmental applications. And so we're trying to ride those waves as we know where those investments are going.

Okay. And the last question would be just looking at your Pharma analysis. If you look at the broad break down of your end customers over there and you look at big Pharma, you look at the generics coming up and then you look at the biotech, so the spending patterns of all three are somewhat different from each other. Could you give a rough breakdown of what that end market mix might look like today?

I don't have that on the top of my head. Certainly big Pharma I would say is still over 70% of the whole mix.

Thank you, Chris. At this time I'd like to call Pat Byrne, President of the Electronic Measurement Group, up to the stage.

Thanks, Hilliard. Good morning and what I'd like to do is to talk about the growth of the electronic measurement business. I want to talk about what are the opportunities, what is our position, what is our source of sustainable competitive advantage and then how we're going to leverage that into earnings growth. So I'll start with the description slide.

This is a $20 billion electronic measurement sector, so this includes both our business in electronic measurements group as well as OSSG. So I'll spend a few minutes going through these adjacent spaces. So $20 billion, $11.3 billion is in the electronic test market. Let me touch on the first few things on the left-hand side first. The electronic design automation, this is a $4 billion business. We have a position here in high frequency RF simulation. These are the tools used by electronic design engineers before the prototypes are built.

It's a very profitable focused business. In this area we're going to be doing fold-in acquisitions to expand our overall position. It's a relatively small business as part of our overall portfolio, but it has an excellent channel. Recently the Eagleware acquisition is an example here. We will be continuing to look for opportunities to expand that portfolio. It also strengthens our R&D market which is a key focused area for this portfolio going forward. The R&D market tends to be less cyclical and higher gross margins.

Moving now to OSS, Tom will cover that so I won't. The next one is the nano tech tools business. You'll see here it's $1.3 billion and this is a whole range of different kinds of measurements, for example, in the semiconductor industry. But recently we made an acquisition of a molecular imaging to get into the atomic force microscope business. This is an interesting example about how measurement businesses develop. As fundamental new technologies come along measurement businesses develop adjacent to them. The measurement business is a derivative business that grows out of technologies.

So as the nano technology business grows the nano technology tools business will grow. So we will be a building a significant business here over time both organically and inorganically. Agilent Laboratories is focused here as well as there's LSCA contribution. This is one of the places where we are working across the Company between the sectors. And then we also, as I said, have entered the atomic force microscope business. We see that as an attractive measurement business going forward.

Now moving to the $11.3 billion electronic test business, you can see the largest portion of this is selling into R&D and manufacturing applications. What drives the R&D spending is new technologies; the deployment and deployment of new technologies in the communications and electronics industry creates the measurement business. The manufacturing section is driven by capacity expansion and productivity improvements as well as new technologies. I mentioned that in the cell phone business.

So these are the two largest ones; we have significant positions there, but there are other attractive adjacent markets as well that we do not have as large a position in. In insulation and maintenance it's a $1.7 billion market. These are handheld products, these are products used for the installation and maintenance of communications and aerospace defense electronics. Leveraging our channel, our brand and our technologies we believe we can build significant business there.

The surveillance business is a $1 billion segment, this is signal analysis and processing. Especially in a post 9-11 world there's lots of signals being analyzed. There are billions of people on cell phones and leveraging, again, our technologies and our brand and our customer relationships we believe we can build a significant business there. And frankly right now we just have a toe hold.

And the last one is data acquisition. This is a market that's an interesting market because here's where physical measurements and electronic measurements combine, and you see the pervasiveness of electronic measurements in the data acquisition business. It is an established market, but we believe with some innovations we will be able to make significant contributions there and I'll mention some of those later.

So that $11.3 billion business, let me also give another picture globally then, the next slide. This is the picture of what that looks like, that $11 billion segment. You can see that it's a global business. It's in all the regions and the reason is the electronics business is a global business. You can see the Americas is relatively larger than Europe even though both economies are around $10 to $11 trillion each. The reason why the Americas business is larger is because of the significant IT footprint in the Americas and in aerospace and defense.

The other factor here is the global nature of the customers. Our customers that we serve are global companies; they compete globally. An example would be you invent a cell phone circuit in Belgium, you work with a partner in San Diego, you prototype it in Taiwan and commercialize it and then you sell it -- then you manufacture it in China and sell it worldwide. That would be a typical wireless customer. It's a global business. So being able to leverage a global sales and support strategy in R&D in every region -- R&D in Taiwan, R&D in Korea, R&D in China, R&D throughout Europe, R&D in the United States -- is one of our core competitive advantages as we leverage the global supply chain.

The third one is what the dynamics are. The U.S., which dominates America, and Europe are becoming R&D centered technology economies as manufacturing grows into Asia. Asia-Pacific then is the manufacturing center for the electronics industry. So those are some of the dynamics that are going on. And again, it's a global thing, it works together. These trends of a very large section growing in these two developed economies focusing on innovation of new electronics technologies is a key driver for why the R&D market is an attractive market because the technologies are being developed. And then in Asia of course, all that capitalization that is going into those developing economies.

Let's move on to the next slide. So what is our relative position? This is an outline of our estimates of our revenues in this $11 billion market against a 19 to 20 -- I think it might be 19 to 23 companies here, I'd have to count them up -- it's about 20 companies. The relative revenues of ourselves, you can see that we're three times larger than the next competitors. The leadership of Agilent comes from two major factors, one is the product breadth of what we offer.

What the breadth offers customers is end-to-end solutions, the ability to put together complete solutions from one company, and the other one is the global reach. Because many of these competitors are either regionally focused or they're product focused, they don't have nearly the position that Agilent does. So our go to market strategy is a major source of sustainable competitive advantage and we want to leverage that into our growth opportunities.

Next slide. So this is the source of our sustainable competitive advantage and what we're going to be leveraging as we look at adjacent growth opportunities. It is really our go to market strategy that is the source and the reason this go to market strategy is so key is that measurement is a value added function for our customers. They're in highly competitive electronics businesses and they want to use measurement to create their own competitive advantage.

And so these deep customer relationships -- are engineers getting ahead of their technology curves and setting the standards and then to be able to turn those into end-to-end solutions and then sell that and support that on a global basis. That integrated go to market strategy is what we're going to be leveraging as we look at adjacent market opportunities for growth.

Next slide. So now what have we accomplished with the financial foundation? This is the financial foundation now we have spent several years developing so that as we leverage the top line it will show excellent incrementals and grow the bottom line and deliver above industry average EPS growth which is our goal.

So you can see what the picture looks like. The progress in the last year -- you can be the bookings are strong, the revenue growth is modest -- Adrian and Bill already outlined the reasons for that. The 31% growth in sector earnings was a lot driven by the gross margin improvements. As the gross margins improve we're able to spend the money on the R&D and SG&A strategies that will leverage the long-term growth. This is the sector performance. So this is both EMG and OSSG.

So what we've built is a robust operating model with improved gross margin supply chain consolidations. Moving forward we'll continue to focus on new products, 40% of our revenue comes from products introduced in the last two years and this will be a significant year of new product introductions. This week in Barcelona, in fact, that's where I'm flying when I leave today, flying over to Barcelona -- we're going to be introducing seven brand new products in the wireless area at GSM Congress in Barcelona. Those products will have excellent supply chain so that we leverage the asset positions we've already got going after attractive adjacent markets with less volatility.

Next slide. So now let me focus on what the growth picture looks like. These four dynamics -- if you look across the dynamics of what is going to drive growth, the top four statements outline what are some of the key themes that are in our -- that sort of underlie the growth strategies. The strength of Asia R&D in manufacturing, Asia is not just going to be a manufacturing center. China graduates almost as many engineers per year as the rest of the world combined. So it will be a very strong R&D and manufacturing center. More value is migrating to software and protocols and that's where a lot of our investments are going forward. Those are attractive markets with good gross margins.

And then the signal complexity in the defense and commercial markets drives the needs for these advanced signal processing applications. And we're targeting three major markets for growth and you can see the six key underlying driving trends. These are the catalysts for growth. Wireless convergence is all about -- well, it's really about two things. One of them is about the broadband deployment of wireless technologies, WiMAX, those kinds of things, as well as the 3G plus technologies.

Triple play services -- there were some questions maybe earlier about some focused competitors in the triple play wireline test markets. Our wireline test business is very broad. We have triple play products which I'll talk about in a minute. Those products are growing strong double-digits right now. They did in '05 and they are in '06. The focused triple play products are in fact winning in the marketplace. And we will continue to invest in that.

The state of triple play right now is legacy spending in the wireline market is slow. People are pulling money out of legacy spending in they're putting it into pilots for triple play services. We expect that to be excellent growth as that moves into more broader-based deployment. So those are just a couple of catalysts for growth in communications.

In aerospace and defense, tests of avionics is all about new technologies and the deployment transformation is really about the new logistic strategy, something called performance-based logistics. The big aerospace defense companies in the U.S. are looking at a transformation of their logistics. In test equipment what that means is that people are looking for modular and upgradeable and software consistent strategies so that the test program sets that are in the government can be maintained as you replace the hardware and underlying test software. So that's the deployment transformation. We have exceptional customer relationships in that and that's going to be a multiyear growth strategy.

And then in electronics it's the growth of Asia and the electronics content. As I think Adrian and Bill both mentioned, our growth in Asia is very strong and this is really the underlying growth of the electronics transformation as Asia builds the supply chain. I don't want to leave out just one of the comments back here is the set of customers we have. As I mentioned in our go to market strategy, it's all about working with market makers, understanding the next technology and developing solutions that they can deploy globally. And you can see a whole set of important customers there shaping technologies of the future.

Next slide. So these are the places where we're going to focus for growth, focus on convergence, focus on R&D solutions for 3G plus, wireless as well as wireline, focus on leading the definition and deployment of the next generation of test systems in the aerospace defense industry, and expand our position in Asia in low-cost offerings as well as in regional solutions.

We have a joint venture in China as well as other investments and we're going to be making very significant new product introductions in the next one to two years to establish ourselves both in products as well as in distribution channels in the low-cost instrument area. These are products less than $10,000 and there's a whole market down there that we have not participated in that we'll be leading in the future.

All those combine -- so this is the what of our growth, is $1 billion in three years, $1 billion of profitable growth in three years which would be taking us from roughly $3 billion to roughly $4 billion. The how of how we're going to do that is outlined below and I've already covered this. This is the go to market strategy of creating innovative solutions in high growth markets, working with market makers, using our geographic and product footprint and differentiating our experience -- differentiating the customer experience through support responsiveness and technical application knowledge.

These are some of the key product platforms we're building on. I won't go through all of these but let me just touch on them. The products on the left-hand side are the N2X and DNA platform, those are our very fast-growing triple play testers. The product next to that in communications is the 8960, it is the product that tests 70% of the world's cell phones. It is now being leveraged into R&D applications which is growing again strong double-digits. There was a manufacturing tester which we've now redeployed.

In the aerospace defense industry you can see our new low-cost spectrum analyzer, that's the first -- we just introduced that product -- the first of a whole series of products of low-cost instruments in the area of below $10,000 and next to it is the LXI products. This platform, LXI or synthetic instruments, has been very well accepted. 23 other companies have joined us in forming the LXI Consortium and the U.S. aerospace defense industry has strongly adopted this as their future technology platform. I expect that to be a very large business over the next five years.

In oscilloscopes, we have grown the oscilloscope business strongly in the last couple of years, lots of new products. And in general-purpose instrumentation the main message I want to land here is we are the leaders in general-purpose instrumentation. We intend to stay there. The innovation is in connectivity and price and performance. We've put together a solution called Agilent Open, which enables general-purpose instruments to be connected to computers as easily as connecting your digital camera to your computer. And it's just that easy. And that's what customers are looking for because that allows them to reuse the asset of a general purchase bench instrument into a test system. And as I said, these technologies and solutions will continue to deliver 40% of our revenue over the next couple years.

So in summary, we are the leader, we're well-positioned, we have a very unique and sustainable competitive advantage in our go to market strategy. We have an excellent operating model and we're committed to driving the growth into the business by using our go to market strategy and looking at these adjacent markets that are attractive. And we expect that to drive above industry average EPS growth over the next several years. So that's what I wanted to say and now what ever questions you've gone.

Thank you, Pat. At this time operator, if you'd open the lines up for questions that would be great.

(OPERATOR INSTRUCTIONS).

We will take the first question from the auditorium. Darryl Pardi of Merrill Lynch.

Could you prioritize the segments of your business for allocating capital to M&A?

The key areas we're going to be looking for M&A would be expanding our wireless R&D position, it is a very good market. We have relatively lower share. We have exceptional customer relationships and it looks like good margin. I would be the top priority. Another key priority would be complimenting our aerospace defense solutions with a more complete solution into those customers and probably about the same level then would be two others -- low-cost instruments, if we could find complementary players, and handheld installation and maintenance products that could leverage our channel.

This time I'll take a question from John Harmon.

I believe you said this morning that much of your market share growth in oscilloscopes was due to the launch of new products. It seems like we're at a point in oscilloscopes now where your two other competitors have also -- or at least one of them -- have also expanded their productline so we had really three rich competitors with full product lines. Are we kind of at an impasse in oscilloscopes now whereas the low hanging fruit from a bunch of new products was off the tree? And if I could sneak another one in when do synthetic instruments become meaningful in terms of revenue?

So on oscilloscopes, I think that we have a relatively low share in the low-cost oscilloscope business. That will be a catalyst for growth for us as we build the distribution channel. In the high-performance oscilloscope business it is a technology game. There's always opportunities to catch the next technology wave and we're committed to working with our top customers to do that.

So we're not satisfied with our market share in oscilloscopes and we're committed to continuing to invest and grow. Synthetic instruments becomes a meaningful revenue stream -- probably it starts in 2007. We're working right now on significant deals with large aerospace defense companies.

Operator, I just want to check to see if there are any questions on the line at this point in time?

At this time there are no questions in the queue.

Okay, we'll continue with questions from the auditorium. Ed White.

I was wondering if -- if you looked at a matrix of this, you've got your markets -- communications, aerospace and electronics on one side, but then you've got the functional specialties of R&D, installation and maintenance and data acquisition. How do those match up? In other words, in each of those three segments what are you going to really need -- R&D or installation and maintenance or data acquisition?

So I think that the -- in communications the big -- the two big plays for us would be R&D first and installation and maintenance. In aerospace and defense it's -- a lot of the diplomat we put under installation and maintenance. We already have a large position in manufacturing and R&D. And then in general electronics it is really about Asia and so I would say that that's where data acquisition fits. That's where general-purpose instruments fit.

Okay. And then a follow-on question. When you look at synthetic instruments can you talk about the difference between a synthetic instrument and a card-based instrument that would plug into a PC or a server chassis, and how they differ in performance, how they differ in market segments that you might be pursuing?

Sure. Synthetic instruments is a -- the key value is people, especially aerospace defense customers have told us, is you have a bench top instrument, say a high-performance spectrum analyzer, the metrology of that which is the accuracy of the measurements down to the device under test is a critical capability for them. They want to be able to seamlessly move that technology into deployment without redoing all of the test systems, redoing all the measurements. It's really about being able to bring that highly accurate measurement into these legacy test systems.

The second key thing is software compatibility of that. And you get the aerospace defense industry, they have a lot of software that's been around a long, long time and these instruments need to be compatible with that software. Sometimes it goes back 10 or 20 years. That's really the core contribution of that. Those are the benefits customers seek. The question is how you deliver on that. So we've adopted LAN local area network as the computer interface because it has lasted a long, long time under fundamentally the same connector scheme and as a result it's much more forward compatible we believe that a proprietary back plane or a card cage system. And we've gotten strong adoption from our customers on that value proposition.

Jack Murphy.

Two questions. Can you talk a little bit about the length of time between when you get an order now and the product actually gets delivered -- what it is now versus what it was a few years ago? And then can you talk about product lifecycle and things in your line spending? Are things spending less time in the line so you need to develop more products just to keep your revenues in place?

We convert over roughly half or a little over half of in quarter orders. So you get ex number of orders this quarter, half of it will ship this quarter. So the delivery times are encountered in less than half a quarter.

What was it five years ago, two years ago?

Deliveries used to be longer. The supply chain wasn't as responsive and so it was less than that. So it was probably 30 or 40% of in quarter orders got converted. The second question had to deal with how long do products last.

You were frustrated. It's 40% of your sales from things (indiscernible) buy in the last two year's. What was it a few years ago? What I'm trying to get at is your business more predictable or less predictable than it was? And do you get more order cancellations now than you did a few years ago so maybe the orders aren't as relevant?

So a few years ago our product lifecycle design, we changed how we do the R&D. It used to be 20 to 30% of revenue was from products introduced in the last two years. As we've shifted the portfolio to go after R&D market, it represents more new products get adopted because it's not going into an established production line, it's going after new technology waves.

Now the fact is that those new technology waves are globally driven so hitting those technology waves is the way that the value goes into the business. So I think it will actually represent less volatility because you're not talking about second derivative manufacturing capacity expansion which is what drives the manufacturing business volatility. So I expect it to be more stable providing we hit these technology waves.

And then the next question is, of the billion dollars you're talking about in these growth initiatives over the next (technical difficulty), how much of that is cannibalistic of existing products versus through places you didn't play before?

That is the net total growth. What I'm saying is 3 to 4 billion. So most of that is going to be going after markets that we do not currently participate in. The underlying growth rate is not 10% in the market so we would have to take market share.

Richard Chu.

Pat, a couple things. Relative to the roughly 5% target that was outlined earlier as a segment growth number for EMG, could you talk about how you see some of the key pieces very relative to that above or below average wireline, wireless, (indiscernible), general purpose? And particularly, I wanted to follow on specifically with a comment on the handset manufacturing portion. Your emphasis today is that you're pushing for incremental opportunities in the R&D arena. How do you put the -- where is handset manufacturing test revenues relative to late fiscal 2004 peaks when before you follow the correction? How do look at the utilization rates on the manufacturing side?

So in call phone manufacturing, that's a very important business. It's a core business that we have. For example Q3 was weak, Q4 was strong, Q1 was strong. So it's -- that's what happened this last year. I think it will be single digit growth this year and the reason is the underlying price points are coming down. What we're doing is we're working a lot on maintaining gross margin through our manufacturing strategy there. But it's not going to be 20 to 30% growth per year. There might be one year where that happens, certainly one quarter could easily have that happen. But the long-term growth rate of cell phone manufacturing tests is in the single digits.

How do you compare versus the peak levels, your revenues?

What was the question?

Your handset manufacturing test revenues relative to where you were at the peak in say summer of 2004.

You said '84, I was trying to remember in 1984 what the orders were. That was a joke. We're below that. But the last couple quarters have been really robust, they've been strong sequential quarters not at that peak, so it's lower than that.

And the other pieces of EMG, you just discussed wireless perhaps going in the single digits, how do you see (multiple speakers)?

No, manufacturing. I said manufacturing was growing. R&D business in wireless is growing strong double-digits.

Does that include infrastructure as well or just R&D?

Infrastructure and R&D. So if you looked at our wireless access triple play I&M products, for example, the DNA product, it's growing strong double-digits.

Where would you put general-purpose and wireline in that?

I would say that right now those are -- there's parts of general-purpose that are growing, as I said, 10%. Some of them are flat to 5%. But I think probably overall it's around 5%. And wireline, as I mentioned, some of the legacy wireline is flat and some of the other ones are -- the triple play is growing strong double-digit.

So while Q1 in wireline is flat, your thought about the 12-month prognosis is consistent with the (multiple speakers).

As the triple play pilots are completed and as that becomes a bigger part of the portfolio then the growth rates will accelerate.

Okay, thank you.

At the some we're going to move forward and move to Tom White, President of our operations support systems group.

Thanks, Hilliard. I'll cover operations support systems, OSS. I think most of you are familiar with the topic. But just to recap, OSS' are the systems that the telecommunications service providers, both wireless and wireline use, the telcos use for helping optimize the operations of their networks, to help them run their services better that run over the top of their networks and increasingly OSS' have been used, as we've discussed last year, to better understand the experience of the individual customers -- customer experience management, customer assurance is an increasing and very rapidly growing sub segment of the assurance OSS market.

Overall the [pan] of OSS is about $13 billion. What we've carved out here is a $3.3 billion addressable chunk of that, and the reason we've carved this out is because this particular sub segment of the overall OSS market can be addressed by making measurements and that's what we do. So this is very much a measurement based OSS opportunity that we're showing on this chart. As you can see the blue, service assurance, is where we are currently focused today and I'll be talking more about assurance. You can also see that recent report by the OSS leading industry analysts calls out Agilent as the number one overall, that's for the fourth consecutive year in the blue part of that.

The reason we show the adjacencies at the bottom of the orange and green, that's customer resource management and subscriber management is because increasingly the data that we're collecting to solve business issues in the blue piece of that is now able to solve business problems in the orange and the green adjacencies. Today we have very little revenue in that area, but we expect that to grow significantly and I'll talk about that as a fundamental part of our strategic intent in a few minutes time.

Just one other point to make about the blue. Service assurance is actually a catchall phrase, it covers three types of assurance -- network assurance, which is the traditional assuring of the network itself; service assurance for the name looking at the service; and also customer assurance. The blue includes three flavors of assurance which, again, is important as we talk about our strategic intent in a few minutes time.

Agilent approaches this in a unique way. There are two ways to solve issues and customer problems in that blue space and it's all to do with gathering data. There were two ways to gather the data. One is the traditional way which is the taking data from networked elements and that's called taking exception data such as thoughts and (indiscernible) and we do that. In that segment we compete with companies like Telcordia, companies like Valiant, Micromuse, now IBM and of course HP.

We also -- and we're unique in this -- we also do what we call measurement based OSS, so instead of taking inferred measurements or inferring data from exceptions on the network we also do deep dive measurements. And in that area we compete with companies like Tektronics, An-RITSU and Tekelec. But today we are the only OSS vendor in the industry that does both exception-based OSS and measurement-based OSS.

What is becoming increasingly clear to us is that the real value in this industry is through measurements, particularly as the telcos want to know more about customer experience. That cannot be inferred, it must be measured. But we think that we're onto something really, really important by having such a large footprint in measurement-based OSS.

In fact, on the next chart I've pulled out the piece of our business that is specifically measurement pro based and you can see against some of our competitors there that we are significantly larger than the competitors. This is a business that we truly are number one in. And in addition to that we are number one in the network assurance piece of the assurance segment. And that's very important, we've got 34% market share and that is critical because what we intend to do is consolidate that position and expand into customer and service assurance over the next months and years.

Our measurement pro based OSS systems around the world, particularly the SS7 product, very important. We now monitor approximately 60% of all of the activity on the telecommunications network. That's phone calls, video calls, data calls, music calls, whatever it is. We monitor 60% of that activity and do measurements on each of those calls. That's critically important because that gives us a huge access to a lot of data which can solve a lot of different customer business problems in several segments of that original play we showed on the previous chart.

The growth drivers, and again, Pad had that alluded to some of these as well -- I'll just cover them very quickly. The top one is very, very important. In any parts of the industry worldwide saturation, particularly in the mobile industry and also the wireline industry, has been reached. I think today there are 108 phones for every 100 people in the UK. That is very much the way that many countries are going. So there's no longer the ability for the wireless service provider to easily grow revenues by growing subscribers. What they have to do is retain the subscribers they've got, make sure they're happy and then grow the revenues, grow the minutes of use of each of those subscribers. So retention of customers and subscribers has become the number one priority for most of the service providers in Europe and North America.

The next one down, it was basically an Internet world to provide a better depth of service, that's no longer the case. Particularly corporate users are now demanding guaranteed service level agreements. Service level agreements can only be managed if you measure what's going on which, again, plays very, very well to a measurement-based OSS Company.

The next one down, we've talked about this in the past. What was simple is now extremely complex, from the days of the legacy phone call which would take five signaling messages, set up a call, a push-to-talk call, can take 1000 signaling messages to set up one call. Multiply that by how many subscribers a typical wireless operator has got, you've got unimaginable complexity. IP/TV is another classic case from the days of making a simple phone call to now having IP/TV in your home, massively complex compared to the previous generation.

Next one down, basic telephonies we've just alluded to is shifting. It's no longer basic; it is just about everything. Triple play is very, very hot, but as Pat mentioned it is very much in a pilot phase in most parts of the world. So while legacy spending is being driven down, the spending on triple play is relatively slow because it's in pilot phase. That will increase as full deployments are rolled out over the next few years. Of course, quad play which is triple play with mobility is being worked on by just about every mobile operator in Europe and North America today.

All of this really concludes with the bottom line here, which is that in an industry that has been obsessed by networks for the last 100 years and worrying about network assurance, a shift was made a few years ago to start to worry more about how the service is performing on top of those networks because after all, that generates the revenue. But now because of this saturation in the market, telcos are increasingly concerned about customer focus, customer assurance, customer experience management. And that is fundamentally combined with service assurance where we are focusing in order to grow our very strong position in the network assurance piece of the assurance market.

This is how we do that. This effectively shows all of the different data sources that we tap into in the network to solve the telcos' business problems. You can see on the right-hand side there, we do do exception-based data to infer measurements, but we also do the measurement data. And we correlate the two, which can provide a very unique view of an end-to-end service. So again, we're the only vendor that does both measurements and inferred OSS today.

There is one other huge differentiator in here. As we look at the different sources of data, you'll see in the middle we do monitor the signaling network, both in the SS7 legacy environment but also the new IP environment. That is the prime source of the data that we collect. But we also use instruments from Pat's shop to do measurements in some of the more leading-edge services where we don't yet have had our own solutions built.

And on the right hand side some new products that are coming out later in the year which we call pervasive probing. What we're trying to do in order to measure the customer experience is get closer to measurements adjacent to the customer, for instance to put software algorithms into the handset, mobile handset to turn every mobile handset in the world into a very low-cost and lightweight test device. That is what we're working on right now.

And on the left hand side another big differentiator, you'll see one called active service test. We are the only OSS vendor today that does this. Our competitors tend to do just the passive probing which I've just described. We also do active testing. We believe that is the key to service assurance and customer experience management and I'll describe active testing in a minute because we launch a new product today in the show that Pat alluded to down in Barcelona and I'll just give that as a cameo in a couple of minutes time.

So today we are primarily in network assurance. 80% of OSSG's business today is in network assurance. We've got a 34% market share. We've also got a small foothold in both customer and service assurance, but our growth strategy is this, to basically consolidate network assurance, hold on to our 34% market share and then to expand dramatically into service and customer assurance by taking this combination of unique data sources that I've just outlined. That is the fundamental strategic intent, it's a very simple strategic intent and one that is being very much accepted by our customer base. We've got over 200 customers in network assurance today and they are literally the Who's Who of telecommunications around the world. And we now intend to expand that to service and customer assurance.

I'll give you this cameo of this new product, active service test, because I think it does a couple of things. It kind of illustrates the complexity out there, but it also shows the value of putting measurements into an OSS environment. Now this is a very, very simple example. So let's assume that a mobile operator wants to launch 20 new services and wants on the 'A' side to transmit data from four different networks to a 'B' side of another four different networks in four different countries which is a very, very simple, very conservative environment. Typically a Vodafone would be operating in 25 countries. But I've taken this simple example.

In order to do that scenario before you can turn on those new services you have to make approximately 82,000 tests, that's a lot of testing before you can go live. Today that is typically done by people with mobile phones in different countries testing every single permutation of what I've just described. And today to do that manually it would take 85 days. The product we launched today is a new generation of something we launched two years ago and it is called active service test and that literally with machines replaces the people and can do exactly the same job in 41 hours.

Now that does two things. First of all, it assures that when the telco turns on those new services they will work with every combination of network, user profile and country, which is very important so you don't have any upset customers. But also it dramatically reduces time to revenue from 85 days to 41 hours and today the testing of that environment is on the critical path of getting revenue. This is a very, very strong value proposition; again, it's a great illustration of what maintenance can do in an OSS environment. And just to reiterate again, Agilent to date is the only OSS vendor that does passive monitoring and active service tests and correlates the two pieces of data that solve these issues.

Okay, we've been very heavily focused on operational improvements along with the rest of Agilent for the last few years. And we've made great strides. Over the last year in OSS we have reduced the quote to cash fine line by 25%. The way we did that primarily was by reducing the project turnaround time from typically 24 weeks, which we had a year ago, down to 18 weeks. We've gone from 24 weeks down to 18 weeks in terms of starting a project to turning the system on in order to get acceptance. That's currently at 18 weeks and now moving down to 16 weeks. We believe by the end of this year we'll be at 16 weeks or less, that is the prime driver for that and that's significant. It also reduces the cost of sales which is quite a lot of our cost of sales is incurred in the field by the people who are actually putting in the systems and installing and turning them on.

Secondly, we have massively simplified the development footprint within OSSG. We've gone from eight R&D sites down to five and two of those in the U.S., the largest one currently is in Scotland in Edinburgh and we also have Beijing and growing very rapidly is India. We believe by the end of this year our India R&D operation will be the second-largest of our R&D footprint in the OSSG organization. But we've gone from eight sites to five so it is far more manageable.

We've also consolidated operating divisions from three; we had three product lines when we talked a year ago, we've taken that down to one. That has massively simplified a lot of things, as you can imagine, including product roadmap, including the underlying reference architecture and the platforms that we're developing in R&D which made things a lot simpler.

We've also reduced the annual breakeven during fiscal '05 by approximately $20 million and in Q1 of this year a further $5 million reduction in breakeven in OSSG's business. And 34% of revenues from products less than two years old. So the R&D programs are having a very, very positive effect there with new business.

And just to conclude in terms of next step and where do we go. Well, we, as I've mentioned, have a very, very strategic (multiple speakers) to extend this very, very strong position, a 34% market share in network assurance and grow into service and customer assurance.

Secondly, to continue the very strong synergy that we've got with Pat's organization in EMG. The instruments in EMG have allowed us to reach first to market positions in SS7 monitoring, IP monitoring and more recently in 3G wireless monitoring. And the way we've done that is by taking some of the leading-edge measurements out of the EMG and putting them as probes in an OSS system and then work on cost reducing those probes as time goes by. That allows us to get to be first to market when a new technology is rolled into the network and we will continue to get that synergy with EMG. So this access to this (indiscernible) of technology and leading-edge measurements in EMG is a differentiator for us as an OSS vendor.

Our ROIC continues to benefit from growing software and support in (indiscernible) revenue. Both our software revenues and our support annuity revenues grew in excess of 25% in fiscal '05 and we estimate -- we predict very strong growth in those two areas this year as well. So we're getting a shift in mix towards more software and a very, very healthy increase in our support annuity business. And we still have headroom in terms of gross margin. And as well as going for growth into service and customer assurance we will continue, as both Bill and Adrian alluded to today, to focus on operational improvements.

We will continue to work on gross margin improvements, in fact the active service test solution that I've just described to you is the next generation of a product that we've had on the market for two years and it has a full 10 percentage points better cost of sales than the previous generation. And we will continue to keep a very, very close eye on reducing our discount levels as the year goes by. And we will also be growing our support and our software revenues again this year. So a very, very strong focus on continued operational improvements throughout fiscal '06 as well as growth. With that I would open for any Q&A.

Thank you, Tom. We'll take the first question from Richard Chu of SG Cowen.

Tom, the marketplace that you described, how much of the 2.2 billion service assurance part of that pie chart is network assurance?

How much of the --?

Yes, the aggregate market that you have on the blue slice you show as 2.2 billion and my question, number one, is really getting a sense of how much of that is network assurance which is what you're (multiple speakers).

It's around approximately 800 million -- $800 million of network assurance and the remainder is obviously split between the customer service assurance.

And then can you spend a moment just describing how profitability for OSS in the last four quarters from this time a year ago has shifted up and down? It's just been described to us as somewhat volatile, but perhaps you can give us a flavor for the changes in the past year? And could you comment on how much OSS grew during fiscal '05?

Yes, I can. In fiscal '05 the OSS business in revenues grew at 22%. The market is estimated to be growing at 8%. And by the way, we'll continue to grow at 8% towards the OSS (indiscernible) for the next three years. So we've got 22% in an 8% growth environment. It is a lumpy business. And I think Bill and Adrian alluded to that earlier. It's a lumpy business, some of the (multiple speakers) in the midteens to low 20's as millions of dollars if they slip from quarter-to-quarter it can have a significant impact in terms of predictability.

The profitability, I can give you a flavor of that. For the second half of fiscal '05 we had a return on invested capital of 21% -- second half of fiscal '05. The first half of '05 was significantly lower than that. We had a loss [making] first half.

John Harmon.

I was wondering what industry consolidation means for you? We know Tektronics will have Inet -- absolutely in a similar situation where you have an instrument maker getting together with a software vendor. Telcordia changed hands. Does the industry consolidation force you to be more competitive? Is that what is pushing you to reduce your costs and what does that mean for the competitive environment?

I think the consolidation issue will carry on. It's a very fragmented industry today. We're sitting at number one in the market, service assurance, with a market share in the midteens. So that gives you an idea of how fragmented it is. It also gives you an idea of the headroom. Not only (indiscernible) Inet, but obviously I'm late to report net debt as well, so similar companies have been bought. The prime, prime reasons that we have been focused on operational improvement is not because of the competitive environment, but because it's our own targets to reach a 21% return on invested capital, so that's what's been driving the operational improvement program.

In terms of differentiating ourselves in the industry, however, I believe with regard to all of the Micromuse and the exception-based data OSS companies, we are massively differentiated just because we do have the measurement capability. And I think from a point of view of the measurement-based OSS companies, we're differentiated for two reasons. We've got the active test in the portfolio and we've also got inferred data as well so we can correlate across the two and provide an end-to-end view of what's going on in the network. But today I think we're in a very, very strong position from a portfolio point of view and I think that will be the differentiation factor as telcos move towards service and customer assurance which really will rely on measurement. You cannot infer customer experience, you have to measure it. So we think we're in a very strong position because of that.

Hi, Robert [Mayna] with Cramer Rosenthal McGlynn. I have a couple of questions. You commented that the project "timeline was reduced by 25%". Can you give us some indication of what the sales cycle is today? And then a follow-up to that is who's the closest comp, who are you seeing most often in deals?

The sales cycles on this business typically are 12 to 18 months. And that has reduced significantly. They typically three years ago would have been two to two and a half years, so they are reducing. In terms of competition, our closest competitor is Tektronics Inet. They also have measurement-based OSS. Now we're considerably larger than them, but they do have the same approach. They do not, however, have the access to this exception-based data, that's a totally different type of platform that they don't have.

And can you give us some color on how large the software and support revenue stream is?

My business currently today is split a third hardware, a third software and a third services and support. And our support annuity is 25% of total revenues.

At this time I want to check to see if there are any questions on the phone line.

(OPERATOR INSTRUCTIONS). At this time, sir, there are no questions in the queue.

Okay, thank you. The next question will come from Josh [Notkin] of [Harvest].

You stated the opportunity in order to smooth revenues to create a ratable revenue stream where you recognize over the lifetime of a contract. And could you give us an idea of the average size of a software contract, software and services together?

The possibility of getting tapped into a more annuity-based revenue flow say in some kind of revenue sharing opportunity with customers is there, it's not one that we have pursued to date. We have offered that in several cases, but customers tend to want to buy this on more of a CapEx basis. That tends to be the way the industry works today. Sell in-service assurance, the reason for that is it's very, very hard to pick the criteria on which the revenue would be shared. Whereas if you're in a billing environment you can base it on either revenues or number of bills or something. But it's slightly more difficult to measure that.

So today none of our business is based on an annuity basis apart obviously from our support business which is entirely an annuity revenue flow. And the second question was -- the average deal size. The average deal size is around about $1 million.

The last question will come from Ed White from Lehman.

I was wondering if you could talk about the customer motivation behind some of this. In other words, if you look at service assurance, customer assurance, is the customer pushing -- the actual final user pushing for this and how important is that to the opportunity that you're seeing?

Okay. So where is the push coming from on Agilent to do customer experience management? It's coming directly from the CEOs of the telcos. I met with several CEOs last week in Asia and I quote, "we want to become a customer experience company not a phone company". The customer delight is very much the flavor of the moment because of the saturation situation and the fact that people want to grow their revenues with their existing customer (technical difficulty). And I think this is more so in Europe and North America, but also starting to hear that even a country like India where there's lots of headroom for growth; however, the high revenue generating customers have already been captured and the telcos want to make sure they keep them and grow their revenues particularly in areas like international roaming. International roaming is incredibly profitable, therefore the only way to make sure you don't lose any is to literally measure the experience of the roamers as they go around the world and make sure that each one of them is getting what they pay for so you can keep hold of them. So this is coming directly as a business requirement from the telcos.

Okay, thank you.

Thank you, Tom. At this time we are going to open back up the line to Palo Alto. Bill, are you there?

Yes, I am.

Okay. We will hear from Bill Sullivan with some closing thoughts and then after that all the presenters will be available for questions and we'll conclude at noon and then that will be followed, for those of you who are here are in the theater, launch upstairs and you'll be directed appropriately. Bill, go ahead.

I'd like to thank all of you for your attention and participation particularly given the logistics issues we had today. We really do appreciate this opportunity to speak to all of you and not only to announce a solid Q1, but to give you a flavor of the focus that we have since our announcement on August 15th. I think the big take aways are that since the announcement last August of the transformation of the Company and our very focused strategic intent, that we have completed these transactions without sacrificing our focus or our market position moving forward.

As Adrian described, we're very, very financially strong. We have a very strong operating model and we have the discipline to continue to leverage that model. And I'm sure you heard in their voices as well as their commitment, each of the group presidents are absolutely committed to leveraging the operating model that we have created over the last year to really focus and consolidate our position moving forward as the world's largest measurement company. So again, thank you very much for your attention and I'll turn it back over to Hilliard.

Thank you, Bill. Pat and Tom, if you guys could join me up here on the stage. And Bill, Adrian and Chris on the line. If there are any final questions for any of the presenters, we have about 10 minutes where we can open the floor and the phone lines to questions. We'll take a question from Deane Dray.

Thank you. I'm not sure if this is a question for Pat or Tom, but it relates to triple play. Just give us a sense for how important is video test in gaining share in triple play given your market position today?

It is important. The reason being triple play, obviously three different services, the quality of each of those services are going to be important so you've got to build a -- measure the quality of the voice, the quality of the data and also the quality of video. So you have to be able to test it both in an R&D production environment, inflation commissioning, and you've got to find a really low-cost way to measure it when it's in operation. And that's going to be the big challenge because you'll have millions of these devices in people's homes. And the margins are going to be relatively thin for the service providers.

So you cannot do anything manual, it should have to be automated. So you've got to find a way to measure the video quality in situ in a very, very low-cost way and we're working on all four of those areas. We think we can do that in the same way as we currently measure the quality of service real-time in Voice over IP. It will be a similar technique that we use to measure video quality in situ.

So do you have in-house capability for video tests or is that an area you would have to invest?

In OSS we have the ability to do video testing I should say, but it's a much lighter weight test than you need to do in an R&D environment.

Are there more questions in the room? How about Darryl Pardi?

This is a question for Bill and Adrian (indiscernible). You've alluded to the desire to get bioanalytical to be about 50% of revenues. Clearly it's a far -- it's a long way from that now (indiscernible) some larger acquisitions. One, how aggressively and what time frame, I should ask, do you think the business can get there? And secondly, can you do a large acquisition in this space and achieve your 20% ROIC targets?

The comment than you had made about wanting to get the bioanalytical sector to the same size electronic measurement is just an obvious great thing to happen. We have made no specific comments that we have a specific plan to get that to happen in this short period of time. As I had said earlier in the call, we think there are exciting opportunities that Chris van Ingen is managing. We're going to look at all those opportunities, both the organic as well as through acquisition, and we'll make the appropriate decisions. It is very important for us as not to lose the edge, lose the focus on the operating model we have and that we want to ensure the decisions we make will truly create sustainable long-term shareholder value.

The next question will come from Richard Chu.

I'd like to go back to the illustrative -- financial model that you put up for fiscal 2007 by segment. I think the point that you made was quite clear, but if you could talk about this a little bit more. The mindset right now I think is one that's characterized by a fairly aggressive approach to things like cost controls, infrastructure cost reduction and spending. And I wanted to get a sense of when you put up that notional '07 model, does it assume that some of these -- most of these disciplines will remain intact or does it assume that there will be some loosening with respect to spending rates as (indiscernible) gets better?

I guess I'll take that one and as the earlier -- this is Adrian -- as the earlier question suggested, the incremental margins even out here are in the 40 to 45% range which we think is pretty darned attractive compared to any of our peers and competitors. So no, there's absolutely no lessening of that discipline around operating expenses. We have worked so long and so hard to achieve this model and this discipline and we've reinforced it with the variable pay for every Agilent employee that's tied specifically to that 21% return on invested capital target and metric. So I think we're doing everything we can to reinforce this as a way of life and then to extend through higher growth on the top line the benefits of that value creation.

To understand it a little bit more, I assume that incremental gross margins will be closer to say 60% plus, so there will be room for you to make some discretionary investments and (multiple speakers). Is that fair?

That is probably fair, Richard.

Okay, great.

And the next question will come from Ed white.

My question is for Bill. Bill, if you look at the -- since August of last year all the restructuring -- incredible amount of work that went into that and getting all of that accomplished. As you look out towards the next 12 months and you prioritize the key things that you want to see Agilent accomplish sort of on a broad scale, what would those be? There are a lot of things that have been talked about with growing the revenue base clearly in opportunities where there's opportunity for expansion. Clearly you've talked about opportunities to further improve the margins and further drive that higher to get above the operating model. But if you look at the real priorities, where do you think those are going to be?

It's was I call -- and I've talked both today as well as internally into the Company as we move phase two of our transformation, it is about leveraging our top-line growth opportunities based on the operational model that we have put in place. That is the number one priority, and I think you can tell both from Chris, Pat and Tom, that is their focus moving forward. We are going to hold our operating model. We believe we have enough momentum in our new products, our diversified footprint of R&D around the world, our presence in every major continent in the world that we can in fact drive the top-line growth faster than market and that is by far the number one priority.

John Harmon?

I was wondering if there are any additional opportunities to prune your product portfolio in general-purpose test? What I'm referring to is the fact that you sold your precision time [voice] business, your clock business, which leaves you the precision motion business. Is that business a cash cow or is there any opportunity to transform it into something that will grow?

That's a good question. We've done some pruning of our portfolio in the last few years based upon profitability and mostly around end market and in the prospects for sustained profitability. We have a precision motion and time business which is consistently profitable with a very strong position and it's the core technology we're leveraging into nanotechnology.

So in fact, that division is now the nanotechnology measurement division. It previously was the precision motion and time division. So basically what it's all about is we make good money there, we have excellent customer relationships, consistently profitable and good use of assets and now we're leveraging it.

Let me just check with the operator to see if there are any questions on the line.

No, sir, at this time there are no questions in the queue.

Okay. We'll continue with another question. Marvin Wong.

A question for Adrian. I'm just looking at the cash forecast for '06 and I'm just looking at the improvement in inventory days, but that there's a use of working capital. I'm just curious if that has to do with the semi products divestiture or why the use of cash in '06. And then the improvement in '07, just what is kind of the target or what's a good target for how much more cash you can get out of working capital going forward. And then I have a follow-up.

Okay, use of cash in '06. Unfortunately that's probably a mix of the various comings and goings between STS and our ongoing business. It also has a little bit to do with the ramp of the business. If you think about how we've started out the year, it's only had 3% revenue growth, but we've said that the business overall had 10% -- 7% or 10% type growth for the new Agilent on page 14. So clearly we will be gaining momentum through the year and therefore it's a little bit of a misperception because we'll use more working capital when business is stronger at the second half of the year.

As far as what are the reasonable targets to expect let's say in '07. I think receivables we have -- really are best in the world there, best in class compared to any of our peers and competitors. And so we would not count on improving that a lot more. I think there is still some opportunity in inventories. Ultimately perhaps given our mix of business we can get down to the 70 days on hand range. We have gone from, candidly, worst to what is to date better than average, but getting to world-class there probably has another, compared to where we are today, 15 days -- 15 to 20 days.

Okay. And a second question, this is maybe for Chris or Adrian. Without giving any sense of timing, what is kind of a target operating margin for the integrated biology unit?

Well, I think overall -- this is Chris -- overall I believe that the total life sciences segments or the integrated biology combined with Pharma analysis should be on a similar level in terms of operating profit and the Chemical Analysis business which is currently around 23 to 24%.

Thank you, Chris. At this time I would like to thank all of you for attending the analyst meeting today. I know it's been a challenge given the weather conditions here in New York, but we really do appreciate your support and interest in Agilent Technologies. And for those of you on the line, hopefully everything came through clear. We appreciate you hanging in there. And to the management team, thank you for being troopers.

Thank you, everyone. And for those of you here at the theater, we will have lunch served upstairs. There will be people outside to direct you. And the management team that's here in New York will be available throughout lunch. Thank you, everyone.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now all disconnect and enjoy the rest of your day.