安捷倫 (A) 2010 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the second quarter 2010 Agilent Technologies, Inc.'s earnings conference call. My name is Yvette and I'll be your operator for today. At this time all participants are in a listen-only mode. We'll conduct a question and answer session towards the end of the conference. (Operator Instructions).

I would now like to turn the call over to Ms. Alicia Rodriguez, Vice President of Investor Relations. Please proceed, ma'am.

Thank you Yvette and welcome everyone to Agilent's second quarter conference call for fiscal year 2010. With me are Agilent's President and CEO Bill Sullivan, as well as Vice President and Acting CFO Didier Hirsch. Joining in our Q&A will be the Presidents of Agilent's Electronic Measurement, Life Sciences and Chemical Analysis Groups, Ron Nersesian, Nick Roelofs, and Mike McMullen. After my comments Bill will give his perspective on the quarter and the overall market environment. Didier will then follow with a review of financial results. After Didier's comments we'll open the lines and take your questions.

In case you haven't had a chance to review our press release you can find it on our website at www.investor.agilent.com. Please note that we have moved the business segments financial tables to the schedules accompanying the press release. We are also providing further information to supplement today's discussion. After you log onto our webcast module from our website, please click on the link for supporting materials. There you will find additional information such as our revenue breakouts and historical financial information for Agilent's continuing operations.

Also in accordance with SEC Regulation G, if during this conference call we use any non-GAAP financial measures, you'll find on our website the required reconciliation to the most directly comparable GAAP financial metric.

Additionally, I'd like to remind you that we may make forward-looking statements about the future financial performance of the Company. These involve risks and uncertainties that could cause Agilent's results to differ materially from management's current expectations. As a result, we encourage you to look at the Company's most recent filings with the SEC to get a more complete picture of all the factors at work. The forward-looking statements including our guidance provided today during the call are only valid as of this date, and the Company assumes no obligation to update such statements as we move throughout the current quarter.

Lastly before I turn the call over to Bill on Friday May 14, we announced the successful close of our $1.5 billion acquisition of Varian. While our prepared comments today focus on Agilent's Q2 results, we will be happy to provide more information around the acquisition during the Q&A portion of the call.

Now let me turn the call over to Bill for his comments.

Thanks, Alicia. And hello, everyone. In a few moments Didier will provide you with an overview of our Q2 financial results. I will provide you with a summary of results, a market perspective, and our outlook for the second half of the fiscal year. Agilent continues to capitalize on the global economic recovery. Q2 orders of $1.35 billion were up 31% year over year while revenues of $1.27 billion were up 16% from a year ago. Non-GAAP earnings were $152 million or $0.43 per share.

Agilent's second quarter earnings combined with solid asset management enabled us to generate $224 million of operating cash flow. We ended the quarter with net cash of $1.4 billion. All regions grew by double digits year over year led by a 24% increase in Asia Pacific. Growth rates in China have moderated from their record highs but remain in double digits. Overall, Agilent's large and established presence in Asia will continue to serve as a strong competitive differentiator. 41% of Agilent's business resides in Asia, a record high percent.

Europe grew 10% year over year while the Americas were up 13% from a year ago. From a market perspective, we saw year over year revenue growth in most of our key markets that we serve. Our Chemical Analysis business had an excellent quarter. Q2 revenues were up 19% year over year, as demand continued to improve in industrial and applied markets. All key end markets were up double digits year over year. Petrochemical plus 30%. Food, plus 15%. And environment, forensics plus 27%. Operating margin was 24%.

From a product perspective, our GCMS, ICPMS and mid range GC platforms each grew in double digits. We also had solid double digit growth in our consumables and services, up 21% and 11%, respectively. We expect future growth to be driven by continued focus on food safety, opportunities in emerging markets and expanding consumables in mass spec portfolios.

Our Life Science business had a solid quarter with revenue up 12% over last year, up 15% if we exclude the Hycor divestiture from last year's base. Operating margin was 14%. Excluding the Hycor divestiture, we experienced modest growth in pharma and biotech of 4% year over year. Academic and government revenues grew 11%. Sales of LSG products and services into applied markets, were up 25% from a year ago.

From a product perspective, LCs were up 28% year over year, with strong worldwide demand. 1290 LCs continued to exceed expectations. LCMS was also strong with increasing demand for triple quad and Q-TOF instrumentation. We also saw double digit growth in consumables in our new SureSelect sample prep product offerings.

The biggest story this quarter was in our Electronic Measurement business. As you recall, from our March investor meeting in New York, Electronic Measurement was a wild card in the recovery with upside potential from our forecast. EMG's Q2 revenues including Network Services rebounded to almost $700 million, 18% growth year over year. General purposes up 31%, while communications revenues were down 3% from a year ago. Q2 orders grew a spectacular 44%. Operating margin was 14%. Our general purpose markets continue to strengthen. Industrial computer and semiconductors posted their strongest results in recent history with revenues up 56% over last year. Performance is being led by an overall improved economy with strength in electronics and semiconductor businesses.

Aerospace and defense was down slightly driven by softness in the US markets but we didn't note any significant change in trends or customer demand. We expect seasonal improvement in Q3.

The communications market was mixed. We saw some sequential growth in wireless R&D although it was down year over year. Wireless manufacturing is improving with low double digit growth over the last year and high double digit growth over last quarter. Demand in Q2 was mainly driven by one box testers and smartphones. On May 1, we completed the divestiture of our network service businesses. From a product perspective our core platforms continued to do well. Our PNA-X network analyzers and PXA signal analyzers continue to be well received by the market. High performance oscilloscopes were strong in computer and semiconductor markets. We recently introduced an industry leading 32 gigahertz Infinium scope.

Moving forward, Agilent is in excellent position to grow during the recovery. Our continued investment in R&D and our strong global presence are foundations for capturing market opportunities. You may have seen by our recent press release announcing the successful close of the Varian acquisition. Teams from both Varian and Agilent have been developing detailed integration plans for the past several months. We've already launched our initial customer communication. We've also developed a detailed operating handbook for our field and sales operations for conducting businesses post close. We continue to strongly believe we'll be able to capture revenue synergies through the addition of the Varian product portfolio.

Regarding the integration of infrastructure our intent is to minimize disruptions over the next several months to ensure both Agilent and Varian to focus on operations and customer commitments. Our strategy is to integrate Varian's core systems and processes into Agilent's operating model. By the end of the calendar year our plan is to integrate our legal entities, core, core to cash processes, services and support processes, sales and marketing processes, web environment, and begin the conversion of the factories to our ERP system. In addition, we've already established inner-Company connectivity and began upgrading network bandwidth to ensure rapid communication and sharing of information. We remain very confident in achieving $75 million of cost synergy over the next four to five years. In addition, we will reach Agilent's effective tax rate by the end of 2011.

For Agilent's standalone in the third quarter of 2010, we expect revenues to grow in the range of 16% to 19% from a year ago. Non-GAAP earnings are expected to be in the range of $0.43 to $0.45 per share compared to last year's $0.15 per share. We're also raising our guidance for the full year. For FY 2010 we expect non-GAAP earnings to be in the range of $1.70 to $1.75 per share compared to last year's $0.80 per share. These numbers are exclusive of the Varian acquisition. We expect Varian to add close to $370 million of additional revenue in the second half of fiscal 2010 starting from May 15. As we have discussed at the analyst meeting, Varian will add approximately $0.08 to earnings per share in the second half.

Thank you for being on the call. Now I'll turn it over to Didier.

Thank you, Bill, and good afternoon everyone. I will now provide some additional color on the second quarter results. First, Agilent overall, then the three segments. And we'll end my prepared remarks with a review of the third quarter and full year outlook. Please note that my explanations will be focused on the year over year variances, and I will report the year over year top line growth percentages with and without the recent divestitures of Hycor and Network Systems. Also, I will provide guidance on the second half Varian incrementals.

Starting at the enterprise level. As Bill stated, we had a strong second quarter. Orders of $1.35 billion were up 31% from one year ago. 28% on a currency adjusted basis. Regionally, Asia Pacific led all other regions, with 35% growth, 30% on a currency adjusted. Followed by the Americas at 33% and Europe which was at 23%, 18% currency adjusted. Revenues of $1.27 billion, were up 16% from one year ago. 13% on a currency adjusted basis. With all three segments up double digits. Excluding Hycor and Network Systems, revenues were 19%.

On a geographic basis, Asia Pacific excluding Japan, once again, led the way with 26% growth. 24% currency adjusted. While the Americas were up 13%, 11% currency adjusted, and Europe was up 10%, 6% currency adjusted.

Moving on to the income statement. Second quarter operating profit of $201 million was $134 million above one year ago on $179 million increase in revenues. Resulting in a 75% operating profit incremental. The key factors driving this performance were volume related gross margin incrementals and restructuring savings, which were partly offset by the impact of the restoration of full pay and higher variable pay. Currency had minimal impact on the bottom line, but did impact the various lines of the income statement.

Turning to the individual income statement line items. Second quarter gross margins at 56.9%, were 5 points higher than last year. And improved 2 points on the volume adjusted basis. And to note, 56.9% is a record high gross margin in Agilent's nearly 11 year history. Second quarter operating expenses increased $22 million. Excluding currency, year over year spending increased $7 million or 1%, the result of higher sales commissions and higher variable pay. Operating profits of $201 million were up nearly 200% from last year. The Company's second quarter operating margin was 15.8%, up nearly 10 points from one year ago. And already higher than our mid cycle target of 14%. Other income and expense was flat from last year. Our non-GAAP tax rate during the quarter was 20%, compared to 21% one year ago. And pro forma net income of $152 million or $0.43 per share compares to $0.13 per share one year ago.

Turning to the cash flow and the balance sheet. We continued to demonstrate strong discipline in asset management. Inventory days on hand at 91 days were 16 days better than one year ago, on $62 million lower inventories. Receivables days sales outstanding were unchanged from last year at 47 days. Given our high profits and strong asset management, total cash from operations for the quarter was $224 million, which represents an increase of $87 million from one year ago. During the quarter, we issued around 5 million shares for $121 million in relation to options exercises. We repurchased about 5.3 million shares, or $165 million worth of shares. As you know, our Board has approved last November an ongoing anti dilutive share buyback program to maintain the outstanding share count at about 350 million shares. With regard to our net cash position, we finished the quarter with net cash of $1.4 billion up $465 million from one year ago.

Let me say a word on the $1.5 billion World Trade debt, which matures in January. We have an option to extend the current deal in its entirety, but are considering several options to reduce the amount outstanding, or possibly pay it off entirely as early as January of 2011, but no later than January of 2012.

Finally, you will have noted that Moody's recently upgraded our credit rating to BAA3. Now we have an investment grade rating at all three rating agencies and we are committed to maintaining solid investment grade ratings in the future.

Now turning to the segment financial results. Life Sciences second quarter orders of $331 million were 15% above last year, and up 11% on a currency adjusted basis. Excluding the Hycor divestiture, segment orders improved 18% from last year. Life Sciences revenues of $334 million were up 12%, or 8% in local currency terms, and up 15% excluding Hycor. Geographically, the Americas were up 9%, Europe was up 4%, Japan was up 27%, while the rest of Asia Pacific rose 25%. Second quarter operating income was $48 million, up 9% from one year ago. Gross margins held steady at 55%. And operating margin at 14% was also flat from one year ago. Segment ROIC was 18%. Looking ahead to the rest of 2010, we expect that second half revenues for Life Sciences will be up roughly 14% to 16% from the second half of fiscal 2009, or 17% to 19% adjusting for divestitures.

Turning next to Chemical Analysis, orders of $231 million were up 19% from one year ago, and up 14% in local currency terms. Revenues of $238 million were also 19% above last year, and up 14% in constant dollars. Geographically, the Americas were up 10% from last year and Europe was up 8%. Japan jumped 46%, while the rest of Asia Pacific was up 28% from one year ago. Second quarter operating income of $57 million was $11 million above last year on the $38 million increase in revenues. Or 30% incremental operating profits. Gross margins improved 1 point at 54.5% while operating margins improved 1 point to 24%. Segment ROIC increased 8 points to 48%. Looking ahead, we expect Chemical Analysis year over year revenue growth of 13% to 15% for the second half of our fiscal year.

Finally, turning to Electronic Measurement, second quarter orders of $784 million were up 44%. Or up 42% in local currency terms. Excluding the Network Systems divestiture segment orders increased 52% from last year. Revenues were up 18% from last year, or 15% in local currency, and up 22% excluding the aforementioned divestitures. Geographically, revenues were up 16% in the Americas and 17% in Europe. Japan was up 9%, as the second quarter marked a return to growth after several down quarters. The rest of Asia Pacific was up 26% from last year, with broad based growth across all countries. Electronic Measurement's second quarter operating profit of $100 million, was $122 million above one year ago on $105 million increase in revenues. Clearly showing the cumulative benefits of the resizing of this business. With a year over year operating profit therefore incremental of 115%. Gross margins rose 8 points 59%. 59% is the highest quarterly gross margin achieved by EMG since the separation from HV more than ten years ago. Operating margins improved by 18 points to 14%. Segment ROIC rose 24 points to 20%. Looking ahead, we expect the market recovery in Electronic Measurement to continue and second half revenue to be up roughly 23% to 25% on an apples to apples basis, i.e., excluding the divestiture of the Network Systems business. On an unadjusted basis the growth for the second half is expected to be in the range of 12% to 14%.

Now turning to the outlook for Agilent overall. I will first give you the outlook for Agilent without Varian and then the forecast for the Varian incrementals. For Agilent standalone we expect Q3 revenues to be about 16% to 19% above last year or 22% to 25% adjusted for the Network Systems and Hycor divestitures. And we expect Q3 non-GAAP earnings per share to be in the range of $0.43 to $0.45, about triple last year's $0.15 Q3 earnings per share. For the full fiscal year, we are raising our guidance on both revenues and EPS. We now expect Agilent's standalone revenues to be up roughly 12%, or 15% adjusted for the Hycor and Network Systems divestitures. We project non-GAAP EPS in the range of $1.70 to $1.75, which is up $0.05 from our previous guidance.

Now, to Varian. Even after the delayed close and the required divestitures, we still project that Varian will add approximately $0.08 to Agilent's second half EPS on about $370 million of additional revenues. With roughly 70% of the revenues going to CAG, and 30% to LSG.

With that, I'll turn it back to Alicia for the Q&A.

Thank you. Yvette, will you please go ahead with the instructions for Q&A.

(Operator Instructions). Your first question come from the line of William Stein with Credit Suisse. Please proceed, sir.

Thanks. The orders number in the Electronics Measurement group was quite high. The growth was very strong. And we've heard a lot about shortages in the electronics supply chain, shortages for components and in particular for some semiconductor test equipment. So I'm wondering if this has any effect either relative to what your customers are placing with their orders on Agilent and also whether it's affecting how Agilent's behaving in the supply chain in ordering components.

This is a good problem to have, Will, having such strong orders moving forward. I'm going to ask Ron to have a couple comments to address both your questions, effect on us as well as effect on the overall market. Ron.

Yes, Will, overall our deliveries are getting longer on certain products, but we have not seen it affect our order rate or order cancellation rate. We continue to make progress to bring in some of the deliveries that were lengthened out due to this quick market recovery. But overall we built $75 million in backlog in Q2, and we will start to ship some of that backlog out in Q3, and bring down the order to revenue gap.

So how far in the future does your backlog extend at this point? Is it well beyond a quarter for a lot of the backlog today?

Most of the backlog will be shipped in the quarter. Some of it actually goes out longer than that.

Our policy is just to book orders at six months in advance, moving forward. So typically one month's orders can potentially be next quarter's revenue, except for the issues that Ron talked about in terms of continuing to work on getting sufficient components in house. Again, EMG continues to be the big wild card and upside on this. It's hard to forecast continued 50% order growth. If it does, we'll have higher forecasts in the future.

Good problems to have, as you said, Bill. Just wondering if I could dig on that last issue just a little bit more. What are you seeing in terms of lead time for components today? Are you seeing lead times continuing to stretch or has it stabilized, are they starting to come back?

We're seeing them typically stabilizing coming in on certain products. In particular capacitors and integrated circuits are the areas where there's the most concern. But again we're making good progress on the supply chain and bringing in our deliveries.

Great. Thanks very much.

Your next question comes from the line of Mark Douglass with Longbow Research. Please proceed, sir.

Good afternoon. Congratulations on EM performance. How much is it driven just by the really strong volume increase and how much is due to further savings following in the quarter, sequential pickup in incremental margins?

Sure. Approximately a year ago, we committed to get to an operating model of 12% operating profit on $600 million worth of revenue by this quarter, by Q2. We not only achieved that model, we continue to bring a nice incremental above the $600 million as we delivered $660 million worth of revenue, and that's why Didier had mentioned the overall incremental for EM relative to last year was 115%. This is not only because of the recovery, we have the strongest gross margins in the history of EM within Agilent at 58% whether you look at it before we include the divestiture or after you include the divestiture. And things overall throughout the whole segment look pretty stable right now, and we're very pleased with where we're at.

Also I think it's a testament to the great product platforms that we've introduced over the course of the year from spectrum analyzers, network analyzers, and of course, our recently released oscilloscope. Not only did Ron's organization re-size for the realities of the downturn but we continued to invest to ensure that we had leading edge platforms and I think the marketplace is recognizing that if you compare our growth versus the market.

Switching gears to Varian with taking so much longer than anticipated. Did it really have an effect on your original plans compared to when you originally announced the acquisition and then that $75 million of synergies, is there more to be had there, it's just a little too early to say?

In terms of where the business is, if you normalize for a full six months, and going forward, the added revenue for the Company without any market growth is about $800 million. That's obviously a little bit lower given that we had to divest three of the product lines moving forward. But given how long this took to get regulatory approval I think we're in as good a shape as can be expected, and both Mike and Nick are quite anxious to fully engage with the Varian teams and try to drive the top line. As it stands today, even with the divestitures, we believe we can find $75 million of cost synergies. Our goal, of course, is to try to find as much as we can. But even with the divestitures, we're confident of the original $75 million.

All right. Thank you.

Your next question comes from the line of John Wood with Jefferies, please proceed, sir.

Hey, good afternoon. Didier, could you give us an update on the cash flow outlook this year, either with or without Varian, however you want to do it. And then do the Capex plans change at all with Varian in the mix now?

No change to the cash flow projections. It's for Agilent standalone, $600 million on operating cash flow basis, and $500 million on the free cash flow basis. So no change. And then we are looking at the additional Capex that will be required with the Varian acquisition, and we'll give you an update going forward. But at this point in time, we're not in a position to give you an adjusted cash flow projection. Clearly Varian has been cash flow positive in the past, so we don't expect that the addition of Varian will change the overall Agilent cash flow. Varian is moving to Agilent with over $200 million of cash.

Okay. Thanks a lot. And then this is probably for Nick Roelofs. The one issue we saw in the quarter was the Life Science incrementals were fairly low. Is that related to the Hycor divestiture? Were there any one time effects in that number this quarter, Nick? And then what do you expect for the incrementals for the year in Life Sciences?

Hycor had a small impact to the incrementals. Q2 is a quarter where, one, we fully restored pay year over year so you have to realize the baseline moved quite a bit year over year. And also our plans were actually significantly lower in incrementals than what we achieved so we did raise gross profit about four-tenths of a point for the quarter year over year. So we did have some positive movers, but getting the pay back into all our employees and getting the variable pay piece really moved that more than any other significant component in there. I'm not sure we gave you full forward incremental at group level. So I'm not sure I should answer that.

And also, as you know, this is the area we're investing as a Company. It's an $18 billion opportunity. I believe during this downturn we've done a very good good job of making the appropriate investments to ensure that we can capitalize on our largest market. And Nick's organization is where our largest incremental investment has been made.

So it's fair to say it was actually a bit ahead of your internal forecast, it just looks cosmetically different to us on the outside.

I would say we're pretty positive and bullish on the incrementals and you just have to look back at the compare to see where the deficit was. Okay.

Thanks a lot.

Your next question comes from the line of Richard Eastman with Robert W. Baird, please proceed.

Hi, just two questions. Bill, how does the bookings number and backlog number look at Varian now that you're in there? They were maybe expected to pick up a pretty strong 18-month backlog in the NMR area from some of the stimulus money and packages and demand. Is that in their backlog and do things look pretty firm out past the traditional six months that Agilent would book as backlog?

They do have a large backlog in NMR and that can be a real challenge for the team under Nick's leadership to continue to work that down. The preliminary data suggests that the backlog is consistent to the revenue number that we have forecasted. I have no doubt during the uncertainty that there has been some reluctance on customers to be able to place orders. Fortunately I think we are very well positioned to quickly integrate the sales team with ours, and to really capitalize on what I belief is a market that is, in fact, expanding.

Okay. And then just secondarily, on the Electronic Measurement side of the business, within the communications segment of that piece, of that group, how do you look at that playing out for the second half of the year? Should we start to see some growth against the easier comparisons or is that going to be more of an FY '11 recovery?

Little hard to say what is going to happen in the market, but I will say that we build backlog primarily in the communications segment. So when you look at the backlog that was built, it was heavily skewed toward communications, and the divisions that ship those type of products. So there is a difference that we see going forward on communications with regards to growth rate, but of course, we're not counting on a big market upturn from here in order to deliver the forecast that we have delivered, that we have given you.

But we should see sequential growth given the backlog build.

Yes.

Great. Thank you.

Your next question comes from the line of John Groberg with Macquarie. Please proceed.

Thanks for taking the questions. Could you maybe just talk about the pricing environment right now. On both sides of the business but in particular on the Chemical and Life Sciences side, you hear that instrument pricing has gotten a little bit more aggressive during the downturn. Maybe you can just comment on what you're seeing.

Before I have Mike and Nick have a comment I will put my editorial plug in that we continue to reach record high levels of gross margin. I think that's a testament to the product offerings we have had and the aggressiveness we have had in terms of lowering our manufacturing cost. Mike?

Building off of Bill's comments, in fact that's what we've seen, a level of stabilization in terms of pricing. And you may have noticed our margins actually increased a point over last year in operating profit at a higher rate than revenue, so we're seeing a more favorable price environment.

And John, I'll add just another comment to that, which is, as you know we've launched our 1290. That's putting price pressure at the low end, but not putting price pressure on the 1290, and that's a good thing. It's consistent with our plans. And you'll see us continue to launch products in the next weeks and months consistent with our R&D investment from last year, so we're not afraid of the pricing issue. In fact, it's the opposite, our high end products are driving that up.

Maybe just to couch it a little differently, I know the gross margins look very good. If you were to parse that out, though, in terms of some of the volume that you're getting and some of the improvements that you're making and how you're designing some of the products, and I think you guys are often considered a low cost manufacturer of these product, if you look at it on the margin expansion that you're getting, the percentage that's driven by cost out, in terms of the manufacturing versus price realization, could you maybe --

I can address that question at the Agilent level. Our gross margin was 56.9% and the year over year improvement of 5 points wouldn't have been from volume, would have improved the gross margin by two percentage points, and that is what Bill has referred to in terms of our ongoing improvement in manufacturing efficiency and supply and all those things.

And overall our discounts have stabilized. Ron, maybe you can talk about it being in the most competitive market on price, talk about some of the discounting that you're seeing.

Sure. So I would just talk about three different factors. First, discounting, as Bill has mentioned. And with regards to discounting, as product availability has lengthened, discounting has been less of an issue. The second issue is with regards to the inherent prices you could charge for your products. And as we continue to focus on technology leadership with our high R&D investments, we're seeing higher priced products with higher gross margins, in general, from our top end network analyzers, our top end spectrum analyzers and now with the addition of brand new real time oscilloscopes. The oscilloscopes that we introduced a couple of weeks ago are the world's highest performance oscilloscopes that deliver the world's highest bandwidth, the world's lowest noise, the world's lowest jitter. All of these things that are very critical to the overall market and to end customers. Not only did we introduce those products, we have started shipment on those products to customers. And that helps.

The third piece is in cost reductions, and we continue to make, continue to have a focus on making sure we streamline our operations. So, one, our discounts remain to be managed very well. Two, our product portfolio has more of a performance leadership characteristic, which adds higher gross margin . And three, we continue to go after costs to make improvements on the order fulfillment side. And all three of those have led to record gross margins for Agilent and

Okay, thanks. And if I could, just one more question on Varian. Bill, thanks for some of the time line updates in terms of normalizing the tax rate. Could you maybe give a little bit more insight into when you might think that you could get Varian closer to Agilent's margin level? And also, obviously it seems like there has been some kind of value destruction going on at Varian from a revenue standpoint. If you have any sense as to how long it might take you to be able to get revenues moving in the right direction again as you've begun to dig into the business.

I'll have both Mike and Nick make a comment on the progress they're making on increasing orders and revenue moving forward. That is priority number one, is to leverage what is now going to be close to, if not broadest, product portfolio in the industry. In terms of the cost side, however, though, we are going to aggressively pursue the cost synergies we have. By far the bulk of that is leveraging the purchasing power we have as combined entities moving forward. Just a 5% cost leveraging on direct materials is $40 million. The teams have identified areas where we can share components across various product lines. We have plans in place to reduce or share or combine sales offices around the world. That will be another $15 million. So we have done really a good job just to date of figuring out exactly what we need to do to be able to quickly get costs out of the system without disrupting the system. As you know, during integrations oftentimes the employees are more worried looking in versus out, and the message that we have clearly said to the new Agilent employees is that we must recapture the momentum into the marketplace. So Mike and Nick why don't you talk a little bit about what you're doing in that area.

Sure Bill. Two comments. I'll make some commentary around the integration efforts and then talk specifically about some of the segments. By the way, we talked earlier about the delay in closing, That, in fact, has been an advantage as it relates to the integration planning. I just returned from Europe, for example, and we had an opportunity to really get ourselves well positioned. The priority focus is on the field and the customers, so I think we're well positioned to capitalize, as Bill mentioned, on the top line synergies, staying close to the customer.

And then, John, when you get into some of the details, you're going to see later on that the businesses are in varying degrees of shape in terms of what segment you're in. The vacuum technologies business, for example, which we will continue to run as a standalone entity, much the way Varian did, continues to do quite well. And as you saw in the recent announcement, it is really capitalizing on return to market growth. Consumables is a great opportunity for us. Priority, will be the first place we actually will be able to integrate some of the Varian portfolio into our Agilent sales force. So we have a number of short-term plans really to start working with the top line revenue piece and really retain those Varian customers and make them Agilent customers where they are today. Nick?

Yes and I'll just add a couple comments on the orders side. A lot of the story, particularly in the research products that are moving in the Life Sciences group is one of coverage. The Varian team has done a great job in the academic markets and some of the niches but they have not been as strong in some of the pharma markets. That's an area where we understand the customers, perhaps not the technology. So blending those two cultures and those two teams will be a great coverage opportunity. And I've been working quite a bit with the Varian people. We're trying to communicate very clearly to the market that we have confidence in this research products group. Imaging is an area that we think we can bring leadership to and we're trying to communicate to the customer base that any hesitation they've had on orders in regards to our performance should go away, that we intend to invest to bring these technologies to product leadership. And that I think will drive the orders lines and subsequently the revenue. We all know that there's a long manufacturing lead in these product categories, we'll work on that as well, but the first place you'll see it is orders and we'll try to give you visibility there.

(Operator Instructions). Your next question comes from the line of Ajit Pai with Thomas Weisel Partners, please proceed, sir.

Good afternoon. Couple of quick questions. The first one is just looking at the operating margin. I think you have highlighted how the gross margins are close to records, especially for a second quarter. But on the operating margin side, even on depressed revenues we're seeing some of the best margins we've ever seen in a second quarter. Can you give us some color as to where all these expense cut backs that you're rolling back on, variable comps, some of the other expense controls, are you losing them, and is the full impact of losing them already in the third quarter or will we see the full impact of that in the July and October quarters?

No, as we reacted to the downturn of 2009, we took $525 million of fixed costs out of the system, and an additional $400 million of variable expense, including 10% salary cut for most of the country. As we go through recovery, we have fully restored pay. We did that on November 1st. And secondly, as Didier had outlined, the variable pay that we saved is going to come back rapidly. It is all self consistent with the Agilent variable pay system which is targeted at 10% at a 21% return on invested capital. It will be the pay for the results for the management team as the recovery happens. And also with the order rate coming in so many higher than revenue, our sales compensation is higher than what you would expect. One thing that we have done, though, that will moderate the second half variable spending is that we have reset the results for the management team in the second half of the year. Obviously the pay in the first half of the year is well over target. It's always hard to predict the future when you're going through a downturn, and so as a result of that, we are resetting the bar for the leadership team, starting with myself, in the second half, which will take away some of the upward pressure that we're seeing in the variable spending as the recovery comes about.

And we do the same thing every semester also for the sales quarter. We have an external rate order quarter and some of that is reflected in our sales quarter for the next semester and that will have an impact on the commission.

Is it fair to say then if you're actually controlling the increase in success based compensation, that the current record levels of operating margins for the second quarter, ex Varian, not including the downward pressure, you'll have enough margins in the near term that you should actually be continuing to set records in op margins, excluding Varian?

If we continue to see the revenue increase and we will continue to be disciplined in our spending. And as Didier said, we have a policy, and we've done it for years, that we reset pay targets every six months. More and more companies are adopting this. It's allows you far more flexibility, particularly in downturns that I think that we will have well controlled expenses and we're continued to commit to the type of incrementals that we've demonstrated today.

When you run the model you'll see that based on the projections, the guidance we've given you, yes, indeed we're expecting an increase in operating profit in the semester, H2 versus H1. So we have not reached a high of our operating profit.

Got it. And then the second question is uses of cash. For many years Agilent was in divest mode and then you started making acquisitions, but continue to make divestitures. At this stage, you've talked about maintaining your investment grade rating on debt. You've used up a lot of your cash with the Varian acquisition. Could you give us some color as to over the next 12 to 18 months, what mode Agilent is in. Are there still some divestitures that are yet to be complete? Do you still have an active acquisition pipeline? And what the priorities for cash would be over the next 12 to 18 months.

We've essentially completed the acquisitions. We have, of course, the final divestitures of the four product lines based on the requirements of the European Commission and the Federal Trade Commission, and we'll complete that over the next two to three days. So other than the divestitures of the four overlap product lines, with Varian we now have a very stable product portfolio. We will soon be in a net positive cash situation, given the cash generation that Didier talked about and the $200 million of cash that Varian will bring into the Company. We're committed to maintaining our stock share count at 350 million shares. And we will, in fact, unwind the World Trade arrangement by January moving forward. Given where we are in the acquisition, of course, the team will want to have some time to successfully integrate Varian over the course of next year, but we would be in a position to do what we've always said is to look at the uses of our cash to accelerate our growth through acquisitions.

But nothing imminent for the next six to 12 months, is that fair?

Let's give us another quarter to look at it. I'm being facetious. We need to make sure that Varian gets integrated successfully and well, and a year from now we'll be in the position to again look at opportunities. Again, this is not counting small bolt on acquisitions. We continue to target $100 million to $200 million a year of smaller bolt on acquisitions and you can imagine that we'll continue to look at those.

Got it. Thank you so much.

You have a follow-up question from the line of William Stein with Credit Suisse. Please proceed, sir.

Thanks. Bill, we haven't really talked a lot about Europe and in particular the recent macroeconomic concerns there and the weaker euro. Could you give us a brief comment on how you expect that to impact your business?

I'm not sure that I have any better crystal ball than anyone else. Our revenue is up 10%. Unfortunately it was down sequentially. There are concerns in Europe. Right now Europe is about 24% of our business. So again, it's the smallest segment from a geography versus the other regions. But we have the exact same concerns as anyone, that slower growth in revenue would have an impact. In the short-term we've got some easy compares. We have a very credible product portfolio. People are investing moving forward, but we would have the same concerns as anyone else.

So that contemplating this, what's gone on recently there, made it into guidance I assume?

I think that we are comfortable with our guidance, with the present state of Europe. Didier?

It's absolutely. consistent. And from a currency standpoint the guidance assumes exchange rate as of April 30th, but the revenue projections that we've provided you are based on those exchange rates. But as you know currency fluctuations have very very little impact, if any, on the bottom line so it's only impacting the various lines of the income statement.

Got it. Thank you.

With no further questions in the queue, I will now like to turn the call back over to Ms. Alicia Rodriguez, for closing remarks. You may proceed, ma'am.

Thank you, Yvette. I'd like to thank everybody on behalf of the management team for joining us today. Please feel free to call Investor Relations with any follow-up questions you may have. And we look forward to speaking with you and thank you again.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.