安捷倫 (A) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2012 Agilent Technologies earnings conference call. My name is Keith, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later on, we will have a question and answer session. (Operator Instructions) As a reminder, today's conference is being recorded for replay purposes.

And I would now like to turn the conference over to your host for today, Ms. Alicia Rodriguez, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Keith, and welcome, everyone, to Agilent's first quarter conference call for fiscal-year 2012. With me are Agilent's President and CEO, Bill Sullivan, as well as Senior Vice President and CFO, Didier Hirsch. Joining in the Q&A after Didier's comments will be Agilent's Chief Operating Officer, Ron Nersesian, and the Presidents of our Electronic Measurement, Life Sciences, and Chemical Analysis Groups -- Guy Sene, Nick Roelofs, and Mike McMullen.

You can find the press release and information to supplement today's discussion on our website at www.investor.agilent.com. While there, please click on the link for financial results, where you will find revenue breakouts and historical financials for Agilent's operations. We will also post a copy of the prepared remarks following this call. For any non-GAAP financial measures, you will find the most directly comparable GAAP financial metrics and reconciliations on our website.

We will make forward-looking statements about the financial performance of the Company. These statements are subject to risks and uncertainties, and are only valid as of today. The Company assumes no obligation to update them. Please look at the Company's recent SEC filings for a more complete picture of our risks and other factors.

Before turning the call over to Bill, I would like to remind you that Agilent will host its annual analysts meeting in New York City on March 8. Details about the meeting and webcast will be available on the Agilent investor relations website two weeks prior.

And now, I'd like to turn the call over to Bill.

Thanks, Alicia, and hello, everyone. Agilent's Q1 orders of $1.62 billion were flat versus last year. Q1 revenues of $1.64 billion were up 7% year-over-year. Non-GAAP EPS was $0.69 per share, and operating margin was 19%. We generated $150 million of cash from operations, and ended the quarter with $1.6 billion in net cash. Our Q1 performance was a solid start to fiscal-year 2012.

Electronic Measurement revenues were $778 million, up 1% over last year. Operating margin was 21% of revenue, a 58% increment for the quarter. We saw strength in Aerospace and Defense, up 5%, Industrial, Computer, and Semiconductor markets were up 6%, with strength in the Industrial subsegment partially offset by continued weakness in Computer and Semiconductors.

We also saw an unexpected decline in the Communications markets, down 8% year-over-year. The causes were two-fold. First, there was a decline in wireless infrastructure, or base stations, for global network equipment manufacturers. This was coupled with a substantial decrease in demand from Chinese infrastructure vendors. Second, there was a significant decrease in investment in RF component supply chain. This decline overwhelmed our double-digit growth in handset test. While we believe this is a pause, we are taking a conservative position in our guidance.

In our Bio-Analytical Measurement businesses, you will recall that a year ago we experienced some revenue delays from the Varian integration. This resulted in easier compares for our first quarter in fiscal-year 2012. Chemical Analysis revenues of $396 million were up 14% year-over-year. Operating margin was 22%. Life Sciences revenues of $461 million were up 14% over a year ago. Operating margin was 14%.

All key markets remain strong. Environmental revenue was up 16% year-over-year, Food was up 14%, and Petrochemical grew 14%. Pharma and Biotech was up 18%, while Academic and Government grew 7%.

We made a number of announcements in the first quarter. First, with our continued focus on maximizing Agilent's operations and improving gross margins, we named Ron Nersesian to the position of Chief Operating Officer. Ron led the recent transformation of our Electronic Measurement business.

Under Ron, we also centralized Agilent's order fulfillment operations. The new global organization should better enable us to leverage our worldwide scale and scope in manufacturing, procurement, and logistics. For example, we have started shipping NMR sample loading automation and [carry] UV-Vis spectroscopy products out of Penang.

Second, we have registered Agilent Infinity 1200 LC and 6000 MS instruments as Class I medical devices with the US Food and Drug Administration. This is an important step for Agilent's strategic initiative in the diagnostics market.

Third, we announced four acquisitions in the first quarter. These include -- Halo Genomics, to which it expands our SureSelect portfolio, and Biosystems Development, which expands our Life Science capabilities in sample prep.

Finally, in January we announced that Agilent would initiate a quarterly cash dividend. This is a reflection of Agilent's financial strength and continued growth opportunities, and underscores our commitment to enhance shareholder value and return.

For the second quarter, we expect revenues in the range of $1.7 billion to $1.72 billion. Non-GAAP earnings are expected to be in the range of $0.71 to $0.73 per share. The midpoint of our EPS guidance for the year remains unchanged. This outlook assumes several factors. One, Electronic Measurement will grow approximately 2% for the remainder of the year. Two, we will see continued solid performance in Chemical Analysis and Life Science, resulting in overall Agilent growth rate of approximately 5%.

Revenue growth will be back-half loaded, and we will have easier year-over-year comparisons. And finally, we will continue to deliver market-leading products while we make progress in optimizing our order fulfillment operations.

Thank you for being on the call. And now I will turn it over to Didier.

Thank you, Bill, and hello, everyone. As always, my comments will refer to non-GAAP figures. Agilent's first quarter results reflected the soundness of our operating model. Revenues adjusted for the changes in exchange rates since last quarter were at the low end of our guidance, while EPS of $0.69 was at the high end of the range as operating expenses were well managed. Indeed, the first quarter year-over-year operating margin incremental of 39% was at the high end of our 30% to 40% operating model of expectations.

Let me start with Q1 orders and revenues. Orders of $1.62 billion were flat from one year ago, and down about 1 point in constant currency. Segment orders, adjusted for currency, reflected a 6% decline in EMG, while LSG and CAG grew 4% and 3%, respectively. Regional order growth rates in constant currency were 6% growth in the Americas, a 2% decline in Europe, 3% growth in Japan, and a 7% decline in the rest of Asia-Pacific.

Revenues of $1.64 billion increased 7% from one year ago, both at current and constant exchange rates. Both CAG and LSG revenues grew 14%, or 13% at constant currency. Adjusted for last year's Varian revenue delays mentioned by Bill, CAG grew 7%, and LSG grew 11%. EMG revenues increased 1% versus a strong prior-year comparison, and were flat on a currency adjusted basis. EMGs excess backlog due to capacity constraints has now been shipped.

Regional revenue growth rates, in constant currency, were -- 3% growth in the Americas, 4% growth in Europe, 10% growth in Japan, and 12% growth in the rest of Asia-Pacific. Our regional breakdown of revenue was largely consistent with prior periods, with 35% coming from the Americas, 26% from Europe, 28% from Asia less Japan, and 11% from Japan.

Now, moving to the income statement. As I have noted in the past, while currency does impact each P&L line, it has minimal impact on our operating margin performance as a result of our geographic diversification and systematic hedging program. Gross margin of 54.9% was essentially flat versus last year, while operating expenses were well controlled, and increased only 2% year-over-year. Consequently, our Q1 operating margin of 19.2% was up 150 basis points versus the same period last year. By segment, EMGs operating margin of 20.6% improved 30 basis points year-over-year, CAGs operating margin of 22.2% increased 350 basis points year-over-year, and LSGs operating margin of 14.3% was up 240 basis points year-over-year.

Non-GAAP net income of $244 million, or $0.69 per share, compares to $212 million and $0.60 per share one year ago. And an EPS increase of approximately 15% year-over-year.

Turning to the cash flow and our net cash position, total quarterly cash generated from operations was $150 million, up $30 million compared to the same period last year. During the quarter, we repurchased 1 million shares at a cost of $34 million. Our net cash position at the end of January was $1.6 billion, an increase of $135 million from the prior quarter, and $1 billion higher than one year ago.

Now, turning to the guidance of fiscal-year 2012. As always, our guidance assumes exchange rates of the last day of the reported quarter. Although the just-released IMF worldwide GDP growth outlook of 3.25% is 25 basis points lower than the assumption in Agilent's previous revenue guidance, we are not revising the midpoint of our revenue guidance except for the currency impact. We believe the most likely economic scenario is indeed a soft first half followed by a stronger second half.

We are projecting a fiscal-year '12 revenue range of $6.92 billion to $7.02 billion, which is based on exchange rate as of the end of January. At midpoint, our guidance corresponds to a 4% growth in the first half, followed by a 6% growth in the second half. And for the full year, corresponds to a 5% year-over-year revenue growth, or 6% in constant currency.

For EPS, we are maintaining the midpoint of our prior fiscal-year '12 guidance, and narrowing the range to $3.13 to $3.23 based on 355 million diluted shares. The midpoint of our EPS guidance at $3.18, reflects 8% growth over our fiscal-year '11 EPS of $2.95, which is consistent with a year-over-year operating margin incremental in the middle of our 30% to 40% operating model range.

Finally, moving to the guidance for our second quarter, we expect Q2 revenues of $1.70 billion to $1.72 billion, and EPS of $0.71 to $0.73. Year-over-year currency adjusted revenue growth at the midpoint will be approximately 2%, while the midpoint of our EPS guidance is essentially flat year-over-year after adjusting for the one-time benefit of the non-GAAP tax rate adjustment made in Q2 last year.

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

Thank you, Didier. Keith, will you please give the instructions for the Q&A?

Certainly.

(Operator Instructions)

Nandita Koshal, Barclays Capital.

Thank you, good afternoon everyone.

Hello.

Bill, I was wondering if you could give us a little bit more detail around the communications end market. I think that was a bit of a surprise to us as well. Could you talk about some of the different pieces in there? Maybe geographically what might be leading to your belief that this is more of a temporary slowdown as opposed to something more structural?

Right. Yes, it's a great question. As you said, we were surprised on the reduction in investment for test equipment in both the base station development as well as the component that go into the radio that eventually ends up into the phone.

Our overall one box tester that we use for cell phone testing was fine. So, needless to say, Ron and Guy have done a lot of analysis. And, I'm going to turn it over to Ron and Guy to give their color commentary of what they're seeing and what they're expecting for the rest of the year. Ron?

Thanks, Bill. As Bill had mentioned the first part of the decline was due to the base station infrastructure build-out. And, we saw the decline not only in the global suppliers but also in the suppliers that are local manufacturers within China.

This, we believe, is a pause in the marketplace as we have seen rapid growth over the last two years. But, there has been a pullback during this most recent quarter. The second part of the slowdown is due to RF components which get fed into the whole supply chain.

And, as you know, Agilent has a very, very strong position in base stations and a very, very strong position in RF components. And, both of those our market positions are stronger in those two segments than they are in handsets. So, that is why we believe it has affected our business.

As we take a look at the forecast going forward, the deals that we have in the funnel, the discussions that we have with our customers, and the economic outlook, we have gone to a conservative estimate of 2% revenue growth for the rest of the year which correlates with the $3.18 that Didier had mentioned earlier. Guy, would you like to add any other comments?

Thank you, Ron. I would just add that, yes, China has been the place we've been exposed the most with this trend on the base station and the suppliers for base stations. Going forward, we believe that base station and ecosystem for this industry will probably stay slow while the handset R&D and manufacturing and their suppliers should keep going as planned.

And, I'll put one additional comment on this. And again, for us having a quarter that goes from October through January, anytime Chinese New Year is part of this quarter, we can have surprises over the decades. Fortunately, Chinese New Year is only every four years.

It's the same quarter as Christmas. So, maybe Guy you can comment on what the outlook's like in February since everybody is returned back to work in China and the rest of the Chinese part of Asia-Pacific?

Yes, bill I would just basically state that we have seen, so far, February being on track with our expectations. And, as I mentioned, base station and the supply-chain for base station would probably stay slow for the rest of this, for a couple of quarters. With the handset part getting back on track.

Okay, that's very, very helpful. And, maybe, Didier, just a quick one on the LSG and CAG side. You have talked about investing in the Varian business in the past. At one point you mentioned it was breakeven. When can we start to see some of that leverage come through and maybe some of those investments start to roll off? Thank you, very much.

Yes, as you know, we don't anymore present Varian separate from Agilent which is one company. And, you've seen -- you've heard the operating margin improvement significant that both CAG and LSG have demonstrated on a year-over-year basis, which were, I would say, spectacular.

This is for a good part the impact of the work that has happened in Varian. And, we still have some way to go. We talked about generating $100 million of co-synergies over 3 to 4 years. The first year was mostly around SG&A. We are now showing the synergies -- starting showing the synergies on the cost of sales. And, I'm sure we'll get a chance to talk more about the actions that we are taking.

And, again, as we've said, both Mike and Nick and their teams, we're in the process of essentially turning every platform that we received through the Varian acquisition to ensure that we have, not only a platform that is highly competitive from a measurement standpoint, but also will be able to be manufactured at a much lower cost. Unfortunately, that can take easily 2 to 3 years to make that transition.

That's very helpful color. Thank you, so much.

Thank you.

Jon Wood, Jefferies.

Hey, thanks, a lot. Bill or Ron, I should know this, but I'd like some perspective on if the RF components related weakness, is that a channel phenomenon? Meaning sell-in sell-through or is that a direct piece of business? Just looking for -- we've heard a lot about distributor inventory destocking in China. And, I wonder if this is part of that or is this completely separate?

No. This is typically a direct sell-through. Whether the RF components that are used for handsets or the RF components that are used for base stations,

But, if there is, in fact, an over inventory situation in the channel obviously people are not going to put in on additional capacity. And, that's the big wild card. By definition, as you manage through any inventory adjustment, people will put in additional capacity on the manufacturing side. How much of it was just a disruption as an artifact of the quarter, how much of it is an oversupply of components in the channel?

Because not only are we not talking about power amplifiers, we're talking about filters, we're talking about capacitors, we're talking about PC boards. I mean, there's all kinds of bits and pieces that go into a radio module just on the handset. And, obviously there are a lot of similar components that go into the base station.

Understood. So, Bill, basically this happens when a phone manufacturer takes down their unit forecasts and therefore they have to work off whatever they -- so, basically the excess versus their prior forecast? Is that basically the effect we're talking about?

Well, essentially, absolutely. The overall demand on the end product is going to affect the supply-chain. Typically, as you know, in the semiconductor industry the supplies always tend to get ahead of the overall demand. What has been difficult, is we've had to natural disasters over a relatively short recent period, right, between the earthquake and flooding.

And so, I think, my own opinion, being an old semiconductor guy, that's why it's been so hard to read the semiconductor supply chain right now. As you know, the SIA forecast and some various organizations are believing that we are in a pause period and will improve in the second half. If that's the case, then just like we said, everything will be fine. But, the signal noise ratio right now is pretty high.

Okay, appreciate the color, My follow-up for Didier. I think you mentioned the -- you burned all of the backlog in the first quarter in EMG. But, it looks like the difference between bookings and revenue is only about $20 million.

And, I thought that number was $50 million. So, any commentary around, or color around that would be great. And, just want to make sure, EMG for the second quarter is below 2% growth is that right? And, it basically accelerates in the back half in your guidance?

Accelerates a little bit in the back half, yes. Yes. But, it is still positive growth in the second quarter, it accelerates slightly for the second half. Because we are talking about 2% growth for the three quarters. Not an enormous acceleration in our conservative forecast, as Bill mentioned.

On the first question, Jon. If you look at the EMG backlog since -- in the last three quarters, it has come down $68 million in the last three quarters. And so, we believe that we are now -- we have the right level of backlog, there's no more capacity constraints, as we have experienced. There is always adjustments.

Probably the hardware component of the backlog will probably come down further. But then, the software component will increase. So, net-net I think that the best assumption is that we are now at a level of backlog that is not hampered by any kind of capacity constraints. And, therefore, anything that had to be shipped has been shipped.

Thank you, very much.

Sure.

Tycho Peterson, JPMorgan.

Hey, good afternoon. Just wondering, either Bill or Didier, if you can give us a little sense of how trends progressed throughout the quarter? Was the communications drop off largely a trend you saw in December? Or if you could just give us a little color as to how things progressed throughout the quarter that would be helpful.

I will have Guy answer that question.

Yes, the communication drop off really happened at the end of December. Early December we were pretty confident on what we were seeing still. And, it happened end of December and, of course, January. With end of January being stronger again.

A point to mention is that a significant portion of the orders were acquired right at the end of the quarter. So, we typically see this type of pattern when people are holding on to purchase orders and they are delaying the capital purchases. So, the last week of the quarter was a higher percentage of the quarter than we typically see.

And, is this changing your way in terms of thinking about cost structure at all? In other words, do you have to step up investment here or alternatively pullback a little bit in light of the communications drop off?

Yes, from my opinion, it's too early to tell. Because right in this period of time, you had a major shutdown similar to what happens here at Christmas. And so, I think the signal noise ratio is high enough.

We have a very good record, strong record, of reacting quickly. But, given what our outlook is, the forecast we have, we can still make our commitments moving forward. And so, we are going to not have any major change to our investment strategy.

Okay. And then, last one. I guess, as we think about your capital deployment strategy, obviously you announced the dividend.

Should we still think about you trying to repatriate some cash this year? I think it's about $500 million later this year? And, should we expect you to prioritize Life Sciences within the M&A strategy? Or how do we think about your priorities?

They have not changed at all. You should expect the $500 million at the end of year. You can tell by the two of the acquisitions that I highlighted my comments, that Life Science continues to be our number one focus. And, I ask everyone to write their congressmen to hopefully get a change on the way foreign profits are treated by the United States government.

And, cash repatriation has no bearing on the -- our capacity to make acquisitions. So, we are not limited because the cash is here or there. Acquisitions, we can fund one way or another. And so, cash repatriation would be potentially just in terms of capital return. But, has no impact on our willingness and our ability to make acquisitions.

Okay. Thank you.

William Stein, Credit Suisse.

Great, thanks. Can you hear me, guys?

Yes.

Great, thanks. I just want to start, again, on the Comm's business. Actually, the statements about the base stations weren't very surprising. I think it's not too dissimilar to what we heard from Aeroflex, Danaher, and National Instruments as well. But, on the RF component side it's a little surprising and I'm just wondered if you think there's any competitive issue in that market for you?

Not whatsoever. It's right in our wheel house. But again, I'll have Ron and Guy comment on that.

No, I don't believe there is. We are on top of these customers. Matter-of-fact, the customers that did not purchase, or that declined, we're working on them right now. And, working on deals that will close as we go forward as opposed to business that has transferred to any other supplier.

Great. And, we talked a lot today about the incrementally weaker outlook in the EMG segment and Comm's and RF components. When we look at Q2 coming in a little lighter than, I think, what the consensus expectation was on the topline, is any of that coming from the other two segments or is that all in EM?

We have -- when you take a look at all the segments we saw Aerospace Defense come in stronger than we had expected at first. And then, again the signing of the bill by Obama at the end of the year has helped us. And, we've seen some money flow up.

So, that segment appears to be strong. Our Industrial segment also appears to be strong. We do take a look at what our order rate is in the previous quarter and what is shippable. So, that has an effect on the seasonality of the revenue that goes -- that comes out the following quarter.

I appreciate that. What I was really going for is -- are either the LSG or CAG segments incrementally weaker for the quarter relative to the back half? Are either those pausing as well similar to the Comm's end market?

Tycho, this is Mike McMullen. Let me just make some comments -- sorry -- my apologies, Will, sorry -- comments on the Chemical Analysis side. We are right on our order expectations for Q1. And, we're right on the outlook for Q2. So, we're right on where we want to be.

Nick?

We're seeing some pretty good strength. Q2 is always a little soft for us. But, we saw a lot of strength, as you saw, in the Pharma market really pulling strong as well as Academics. So, we're not looking for any big pauses.

Yes, if there's any message, even though -- obviously, the guys have an easier compare because of the Varian's miss of $30 million of revenue a year ago. Even if you factor that out, our Analytical business continues to be very, very strong. The story here of the quarter is we had a surprise in Communications. That surprise, based on our forecast, will not have an impact on the midpoint of our EPS guidance for the year.

It sounds like you're doing better than many of your Life Science counterparts. I appreciate the details. Thanks, guys.

Thank you.

Derik De Bruin, Banc of America.

Hi, good afternoon. The -- that you're looking for 2% local currency growth in EM, could you remind us what the LS and GNAG outlook are for the rest of the year? Or how you're factoring those in?

Yes. So, it's about close to 7% for the reminder every year, for BAM.

Okay. And, I guess your commentary the Academic market has been strong. Was that still -- was that both US and Europe? Or was that still mostly Europe as you saw last quarter.

Nick?

Yes, actually the strength was pretty good across the board. Europe was a solid number for us, solid single-digit. We had double-digit growth in general across the board as the LS total. And, Academics mirrored that. Obviously, they weren't double digit. But, they mirrored that regional distribution.

So, we saw pretty good strength. US, still a little bit softer than we had hoped. But, as most of you guys saw, last 48 hours Obama put through a proposal for a flat '13 NIH budget. So, a lot of optimism because that was the nervousness. So, we'll see how that translates in orders this 48 hour old comment.

Well, I don't -- I mean, just from, certainly, from our Washington consultants it doesn't sound like that there's much hope that that, whatever Obama put forward, is going to last and survive whatever the Congress decides to do with it. So, that may be a little optimistic. On the rest of the EM business, outside of Communications, are there any signs at all in the Industrial that things are coming in a little bit -- are starting to turn there?

Be a little bit softer? Are you getting any hints at all? What I'm getting for is that are we potentially looking for a surprise on the Industrial side?

The Industrial side was incredibly strong. It was pulled down, as we said, on the Comms and Semiconductor side. The Industrial part of our business was well above expectations. And again, have Ron and Guy make some comments about where we're getting -- it's getting the strength on the Industrial side.

On the Industrial side, we have a very broad portfolio that plays into the different marketplaces. And, that -- we saw that and we had double-digit growth in that segment this quarter. So, things look very, very good in that area. Automotive is a place where we have seen some strength. And, I will let Guy make any other comments.

Yes, I would say our overall Industrial, Computer, and Semiconductor was up 6% in Q1. We see this ease down, obviously, to, as we say for EMG, at 2% total for the rest of the year. Some of the very strong business we got, for instance, the boat test activities were very good in Q1. And, also some very good automotive business.

So, the double-digit number I was referring to was just -- was the Industrial sector where you asked the question.

Great. Thank you, very much.

Jon Groberg, Macquarie Capital.

Hi, thanks a million for taking the questions. Can you hear me okay?

Yes.

Just one kind of clarification. If we think about China, we heard from a number of companies within the Chinese area where things seemed to have slowed. I know you had the New Year issue. But, how are you thinking about just the overall business in China? And, I guess, in particular a little bit more on the EM side since there's a little bit more exposure there?

Yes, I think the best one overall, I mean, anything that's well-documented, that the electronic side in China has got pressure on it. And, the good news is that our Analytical business, both in Chemical and Life Science continues. But, I'll have each of the three group Presidents give a comment of what their outlook -- what they are seeing in China specifically. Guy?

Well, as you know, China has been very strong for us for the past years. And, we see China very related to the comps overall activities both on the base station and handsets. So, we will see a slowdown in China compared to what we have seen in the past years.

Mike? For chemical?

Outside of the discussion earlier about the pause at the end of the quarter because there was nobody in the office for two weeks to take orders. The overall market still remains very robust and strong in the Chemical Analysis business from the food marketplace to chemical and energy, environmental trends. So, very strong demand. And, the comment that was made earlier from the Guy in terms of the start to the quarter, Ross is seeing a very strong start in China as well this year in Q2.

And, I'm just going to echo Mike's comments. No real change in trajectory. A lot of investment in Life Science. Both the Academic and therapeutic levels. And, we did see the Chinese New Year effect. And, we did see some strength in the last couple of weeks as those orders start coming back in.

And then, Bill, maybe just a broader question for you. As you think about that Electronic Measurement business, some peers of yours will, even though they're not seeing things slow at the moment will look at macro indicators and PMI, and whatever, and will forecast the business just based on that because they know how cyclical or how tight it is to those markets. Is there any -- does it make more sense, maybe, for you to instead of just looking at the current momentum in a business but maybe look at some of those macro factors and use that in forecasting your outlook for that business?

Well, we do. And, it's no secret that our correlation in the past to SIA, which we don't like to talk about as much, and of course, PMI we know exactly what the correlations are that do that. But, at the end of the day it is -- we have thousands of sales people that are out there with customers.

And, we know what the overall macro environment is. But, there are just deals that are going down. And, if we get there first and have a better solution, we can sometimes offset some of the macro trends. But, we do exactly as you suggest.

And, obviously when Guy goes to Ron with his overall proposal to grow, we know that macro environment is. We have a very detailed analysis to understand where the competitors are, where the competitors are strong, where their weak. But, at the end of the day, we have to assign order quotas to thousands of people. And, it is very, very bottoms up detail of what we can do.

Okay. Thanks, a lot.

Ross Muken, Deutsche Bank.

Hi, this is Vijay in for Ross. Thanks for taking my question. Could you comment on the strength seen in Pharma? What is driving the strength? What are you seeing in HPLC? And, how is sustainable, I guess, is this strength going forward?

Nick?

Yes, Vijay. Really good question. We continue to be on the same theme which is we see a technology upgrade going on and we see an acceleration of the replacement cycle. We're about halfway through that acceleration of replacement cycle that we've been seeing and talking about and that's a big driver.

A big surprise, in a good way, to us was the strength we saw in European Pharma. So, not only the 18% overall macro but Europe was very solid. And, that speaks to me as being a technology upgrade. Were seeing a lot of mass spec as well as LC going into European Pharma. So, we think that's a biomolecule investment lends one quarter of pretty solid results on top of a pretty good secular.

Sure. Maybe digging on in an earlier question on a dividend policy. Could you walk us through the rationale behind initiating a dividend policy? What was the thought process?

The thought process was very, very straight forward. As you know, we have substantial amount of cash. Most of that cash is trapped outside the United States. We are absolutely committed to being a high investment grade company. So, we're not going to borrow against that money to return cash back to the shareholders.

Even though we have a long history of already buying back $8.5 billion worth of stock. Our number one priority continues to be in acquisitions. But, we are a conservative company and we will not make an acquisition that we can't get back our cost of capital. So, in this environment, what would it take to attract new investors.

There is a growing segment of investors who are demanding to have some sort of dividend being paid for them to be able to invest in a company. 400 of the 500 S&P 500 companies today all pay a dividend. And so, as you go through that rationale, an environment that I believe will continue to have low interest rates, by paying a dividend opens up the potential for investors to buy Agilent stock. And, obviously reward the existing shareholders with a dividend and payback that is very measurable and not at the mercy of a buyback.

Thanks. That was very helpful. And, maybe if I could squeeze one last one in, and apologize if this has been asked. Did the Chinese New Year have an impact in the quarter either on orders or revenues?

Did have an impact?

Yes.

Well, sure it had -- you can't shut down, as Mike said, the last two weeks of China and have an impact. That was in our forecast, right. We knew this. Every four years this event happens in our Q1. The analysis we do, just from the surface, believes the impact was 1point Delta, right.

But, it's hard to tell because behavior changes. If you are going to shut down, why am I going to take the delivery if I don't need it? Do I need the components? We do the same thing in our own factories. So, it's a very difficult event for us to fully quantify. Over the decades, Christmas, you know exactly what happens in the West at Christmas during the December time period.

We know what happens on Chinese New Year. When they're both together like that, it's always interesting for us. But, given the shift of our business into more countries that celebrate the Lunar New Year, we just have more -- a little bit more volatility when we have this event that shows up every four years.

Thank you. I'll step back in the queue.

Richard Eastman, Robert W. Baird.

Just a question perhaps for Ron. When I look at the EMG piece of the business, and we dropped the sales growth expectation from 4% to 2% for the full fiscal year. Is the majority of that, or is all of that, decline really calculated based on your current expectations for the communications business? As we -- basically we had a very good quarter in general purpose, in Mil Aero, is the outlook for those two pieces of the business relatively unchanged?

I would just start by saying one percentage point of the Delta is currency related. So, volume-wise you're talking about one percentage point reduction. Go ahead.

Although we saw the Aerospace Defense business being strong we have not expected it in our forecast to be as strong as it was in Q1. And the same thing with regard to the Industrial market. So, the other markets we've left relatively flat, or relatively conservatively, and we've adjusted the Communications market as we have spoken. So --.

Are you willing to admit to some share gains on the handset side?

I don't think that that's something that I have concrete data on, on the handset side. I know on the base station side, the component side, we're very strong. And, we have grown faster than the competitors in the last two years. But, on the handset side I think there's a couple of good competitors that we're fighting toe to toe with. And, it's going to continue that way for a while.

Okay. And, just a last question. When I looked at the volumes and the expectation for EMG sales growth for the balance of the year, is there -- are there any significant puts and takes at the margin line? Or, is the operating margin for EMG likely to settle in here plus or minus a point, I guess, with sales mix?

We're committed to the 30% to 40% incremental model that Agilent has. EMG has been a 40%. And, even this quarter with the Communications surprise we delivered a 58% communication -- incremental. So, we feel very comfortable that we're running the business very efficiently and effectively given the macro situations that goes on. And, I don't anticipate any major changes from the path that we're on to deliver to our model.

Very good. Thank you.

Doug Schenkel, Cowen & Company.

Hi, good Afternoon, thanks for taking the questions. Actually, maybe a follow-up to that last one. Very specific to fiscal Q2. When I play with my model a bit, if I take my EMG down to levels you describe, my EMG revenue growth down to levels that you describe in your prepared remarks, it doesn't -- it looks like you guys are actually building in an incremental that's much lower than the norm.

I know over the course of the year you are expecting to stay in the normalized range. But, I guess what I'm getting at is if I take my EMG number down, if I don't take my incremental down in that group I have a hard time getting to your EPS number for the quarter. Any chance you could provide your assumption for incrementals in EMG for Q2?

Yes, I will take the question, Doug, this is Didier. When Ron talks about committed to the operating model, the operating model does show that below certain revenue growth, you do have a decremental, not incremental. EMG did a fabulous job this quarter delivering stronger operating margins on very small topline increase and huge incrementals.

I would consider that to be exceptional. In Q2 there's no doubt that as we envision a 2% revenue growth, the kind of incremental that our model delivers normally you would have a decremental. We will have an incremental, but it's going to be a very small incremental. And, again totally in line with the operating model.

With 2% revenue growth, it's a different story than the 4% to 10% we had talked about. But, so, there will be a small incremental. But, certainly not in the 30% to 40% range considering the only a 2% revenue increase.

This is [Alad], we got a previous question are we planning any cutbacks. We have quite a few product launches in Q2, particularly on the Analytical side. And, we have made a decision given the situation in Communications is an anomaly, how quickly will the pause -- or how long will the pause be.

We are going to continue to and stay the course through Q2, get the products out, moving forward. As you said, over the year, we will look fine. But, I think doing something dramatic in Q2 across the company, particularly given how strong the Analytical business is wouldn't be a prudent decision.

Okay, that's very helpful. A higher level guidance question. You guided for stronger growth in the second half versus the first half. Is this predicated on improvement in the economy or is this largely a function of comparison?

There is no doubt that all the economies that we follow, track, do anticipate a small improvement in the second half. If I recall, the numbers last I've seen, on average, the expectation is that worldwide GDP will grow about 3% for the first half. But, more like 3.5% in the second half moving towards 4% in the first half of the following year. So, there is a little bit of tailwind coming from the macro economic situation.

We also have a much easier compare. Like all the talk we had about Communications, for example, this quarter, last year Communications improved 45% year-over-year. So, our compares are very -- in Q1 our compares in Q1, and still Q2, are very challenging. They get much, much easier in the second half. So, that's also something to take into account.

Okay, and if I could sneak in one more. Another question on Lunar New Year. I know it's always tricky for you guys to forecast when this happens, when it falls in fiscal Q1. But, my guess is you can't quantify the impact exactly.

But, could you at least say whether this was close to -- whether the impact was close to what you had planned for? And, how the more favorable comparison in fiscal Q2 comes into play? Thank you.

Yes, and again, like I said, I don't want to use the Lunar New Year as an excuse whatsoever. We knew this was going to happen. We made our forecast. And, we're off by effectively a point.

So, that's shame on us to be able to make that happen. Moving forward, and as we said, it appears things are going back to normal in Q2. I mean, it's our responsibility to forecast that. It's just difficult to know exactly what is going to happen. And then, you couple that with well-documented event, particularly on the Comm side, that there could be a buildup of excess component capacity.

So, how much of that is just purely adjustment of inventory, which has got to be most of it. How much was it just the behavior because you had a major holiday in January. And, it's, quite honestly, it's hard for us to know exactly what the answer is. But, we obviously missed what the expectation was based on absolute demand in the component side of RF as well as the infrastructure.

Paul Knight, CLSA.

Hi, Bill. Could you talk about the market for LCMS? Where we are in the conversion rate, to high pressure, the color in those markets?

Sure. I'll have Nick answer that question. But, as you can tell we continue to do very, very well in this market.

Yes. And, Paul, just for clarification before I answer. Are you talking about LC or LC MS.

Let's start with LC.

Okay, both. Okay, let's start with LC. Yes, we are seeing tremendous demand for the UHPLC method. And, therefore we are seeing more than 50% of the units going in the market being UHPLC capable. And, that, by the way, is both an Agilent statement and a market statement.

So, while we still see a lot of people on the old methodology they are buying UHPLC capable machines. We think this continues to be a really strong technology upgrade vector. It's the comment I was making earlier about technology upgrade in Pharma. Even in Europe going on. So, a really strong market. That market is probably going in the upper single digits.

And, we're doing a little bit better than market. So, we're pretty pleased with our strong upper single-digit growth there. In the case of the mass spec market. Tremendous technology waves going through not only the Life Science specific customer sector but also in the applied markets like food and environmental.

And, so, we're seeing a lot of strength. We had very, very solid double-digit growth in mass spec for the quarter in revenue. And, really nice momentum going forward. So, that also is seeing a technology push at the triple quad and multisector end of that market queue off as well.

What do you think all of the sequencing activity occurring right now means for Agilent?

That's a great question. We're in that market not in a box. Right now that's a good thing to be. Is not in a box. We are in the reagents the go in front of the sequencers.

We think there is a lot of installed sequencing capacity at the GigaBASE large center world. We see a lot of installing of instrumentation going in the personal sequencer world. And, both of those things are really positive for somebody who is in genome partitioning.

Because we think the personal sequencer world is definitely going to be dominated by partition genome subsets and kits. And, we're seeing that GigaBASE world start to talk more about exome rather than whole genome. And, you've heard the big box guys make comments, just recently, on how their new boxes are going to do exomes fast.

You're starting to see actual data in their marketing speak or from the two big CEOs in this space about how they can do so many GigaBASEs or so many exomes. So, we're pleased to see that that terminology is getting into the market.

Okay, great. Thank you.

Mark Douglass, Longbow Research.

Good Afternoon, everyone.

Hello.

Hi, Mark.

Ron and Guy, can you talk about your O-scope growth? And, was that, at least, partly a reason why maybe your Industrial was so strong?

The oscilloscopes play not only to the Industrial market but they also played into the computer market. So, we don't give those stats out on a quarterly basis as our competitors eagerly wait for our announcement. But, we have a very solid product line in that area. And, we are very happy with the share gains that we've made.

Okay, so you still believe that you're making share gains with your -- especially on the low-end oscilloscopes then?

We've done a very good job and we've gained share at the low-end and the high-end. If you look at the macro trends over multiple years, in any quarter or any period, someone could claim that they've done a little better or a little worse depending on what they shipped, and what the flow through, and what went into distribution. But, our gains in oscilloscope market share have been second to none for all the product lines we have in the company.

Right. Okay, thank you. And then, in looking at the Americas, grew 3%, can you discuss between the segments how they all faired? Were they all around the 3% range? And, what your expectations, particularly in the US are?

I'll take that one. At constant currency, the Americas, in terms of revenue, yes, grew 3%. CAG and LSG had phenomenal growth. And, EMG had a decline.

Okay. And, for --.

The Americas was the only region that EM had a revenue decline.

Absolutely.

Oh, really. Okay. So, most of the Comm was --?

Interestingly, just to complement, also, order-wise, to be precise, EM had a 6% increase in orders for the Americas. So, it shows -- sometimes things can be a little bit lumpy.

Especially when you play into the Aerospace Defense market where you see a difference between orders and revenue.

Yes.

Okay, and that explains a lot of it?

It explains part of it.

Part of it, okay. Was Comms also weak in the US? Versus Asia?

No, there were two areas that were particular -- there were base station manufacturers in Europe that we saw some weakness. And then, obviously the ones in Asia. So, primarily the weakness that we saw in base stations was in Asia followed up by Europe.

In fairness, the absolute correlation between where the order gets made and the revenue gets made and delivered, I would tend to look at these as macro trends from the region. To dig down by region into product line is highly problematic given how global procurement is done in this world today.

Okay, thank you.

Isaac Ro, Goldman Sachs.

Yes, good afternoon, thank you are taking the question. I think the EM and the Life Science product cycle is relatively picked over. So, I did want to spend a moment on the diagnostics initiatives you mentioned in the prepared remarks.

Specifically, what are some of the next steps that you guys are working on for product development in that area? And, what kind of investments do you need to make at the margins for channel development as you move forward this year?

Good, I'll have Nick give an update. And, again, we are going to go into a lot more detailed in our analyst meeting next month. But, Nick, why don't you give an overview of where we are.

Yes, so, thanks the question, Isaac. And, as Bill said, we'll try to give you a lot of detail on the 8th of March. But, basically remember that this is still a small piece of Agilent. We're just getting our toe in the water here. We've registered factories, as you heard, a couple of quarters ago.

We've now registered a couple of critical product lines with the US FDA. We're continuing to produce a few things in the cytogenetics area that we're talking to the FDA about as well on the reagent consumable side, those will be micro arrays. We do not yet have a big push here. We do not yet have a big significant presence in regulatory or clinical trial management.

So, those are elements that we'll need to work through. And, those are elements that are gaps. Not to mention, as you pointed out, how do we get to the customers and how do we educate the doctors. And, those that we are aware of and reimbursement is something we're also aware of.

And, as you know, in the last seven years, mostly organically, we have really built up our Life Science capability. That was task number one. During the course of that, we had brought in-house the reagent capability, automating capability, the recent announcement that we made this quarter. So, we're putting all the pieces together.

As you know, we inherently are an organic growth company. Moving forward we're obviously going to look at ways to be able to accelerate Nick's success through additional acquisitions. But, I believe that our Life Science base is solid. And, the diagnostics is the most next logical place to put our toe in.

Sure, yes, that makes a lot of sense. If I could just follow up with another thought there. If I put the comment you just made an the acquisition task in context with the dividend, and all that, I think we can all agree that some of the diagnostics assets that we've seen trade the last couple years have gone at pretty interesting premiums. So, is it fair to say that if you guys find assets that you find interesting in diagnosis you might be willing take a longer horizon for your return hurdles that you might have also in the business?

We will not make a bet that we don't have high confidence that we can get a return in the lifetime of our shareholders.

I think that was a double negative, but I will take it. Thank you.

Ajit Pai, Stifel Nicholas.

Yes, good afternoon.

Hello.

Hi, Ajit.

Two broad areas, I think, I'm curious about. The first is looking at the Electronic Measurement business. And, the source of weakness there, I think, one of the areas you highlighted was components and the wireless. So, my understanding of the point at which you start out your semiconductor product and go viral, was that the vast majority of the components business, especially into handsets, went out of that business.

But, you mentioned not just infrastructure components but also power amplifiers, things like that on your commentary today, I think, or during Q&A. So, can you give us some color as to what is the component percentage of that business right now? And, what the strategy is and whether you're actually competing with Avago in that business or you're still focused on primarily the infrastructure side. So, that's the first broad area question.

Yes, first of all, we're not making any comments about Avago. Avago does, in fact, supply RF components into the handset market. Moving forward, we've been very clear. We believe the handset test market is 25% of the total market. The other 75% is all related to the components that go into base stations and components that go to handset, that's what were talking about.

The biggest impact is in the smaller components that go into handset. Obviously, when the infrastructure base station people cut back, that's going to be impacting that component supply chain. But, the component supply chain going into handset is dramatically bigger and that is where we saw the impact.

Yes, but you're only seeing it from the test side over there. It's not components that you're selling into.

We don't -- components business. That's what I thought you were thinking. So, we're not competing with any of the guys in this scene. We're not selling components, we're selling test to people.

At all. Got it. So, that's what I was talking -- okay, so, it's purely from the supply-chain correction over there impacting demand for your test equipment. But, there's nothing that you're selling directly into the handset?

Exactly, no.

Okay, got it. So, I just wanted to satisfy that to ensure that wasn't something that I missed out on. The second area is just when you announced the acquisition of Varian and you talked about the Delta between the gross margin in traditional Varian products and the Agilent similar products, and where they could be, there's about 1,000 basis points Delta there.

And, you had also identified opportunities for both the Life Science and Chemical Analysis business, to shift towards this thinking to Penang and [Deon Fes Cluviare] and get benefits from those businesses by doing that shift in production. Could you give us some color as to how much of that Delta has been captured and how much more room is there over the next couple of years? To improve those margins further and how much of the shift is still left in terms of production over there?

All right. Of the $100 million of savings, $35 million is in corporate overhead. And, we have completed that. And, you can see it in the -- our expense structure. The other $65 million is all in manufacturing. 1 point, we will get 1 point this year. It's going to be backend loaded.

But, we are going through and redesigning every one of these products. We're going to do it right. And, we are very clear it's going to take us at least three years to be able to get through this process. I have the highest confidence that we are going to do it, but we are going to do it right.

Right. And, in terms --.

Mike, has a comment because he has most of the project.

Ajit, I just wanted to, maybe, add some comments. We're right on our internal plans in terms of the product transfers and the internal gross margins. But, also, this comment around the refreshing of the portfolio, which will drive not only improved gross margin but also improved market share. We just launched a number of very exciting new products.

And, we just actually finished up a division review with Bill. And, these products are exceeding our internal forecast. So, the portfolio strategy is coming together as well. It will be my teaser for the March analyst meeting. We're going to go into some detail. But, we are right on our plans we put together.

And just one example that we had on the AA. We introduced the world's first microwave A. That essentially will allow this instrument to be closer to some of the uses such as in mining. And, not have to put in an infrastructure to provide, for example, argon gas. Here's an example where you spend money, Varian actually developed the work, they just didn't have the money and the opportunity to do it.

We finished that up. It would've been easy to tear the cost out, take their existing AA, and just transfer it to Penang. But, were not going to take market share over time. That's our strategy. We've been very, very clear on that. And, I have high confidence that we're going to make it happen. Ron?

I also want to comment that we've announced a new OF organization, or order fulfillment organization, that is focused on getting the absolute maximum leverage out of Agilent. And, that includes for our instrument products, the building of our products, the logistics, and the supply-chain. And, that is something that is brand-new and we'll be updating folks on March 8 at the analyst meeting.

So, it's fair to look at the beginning commentary from the gross margins on the Electronic Measurement side, that there is a potential for negative leverage as things go down. But, the vast majority of the efficiencies that when we gain by improving costs on the Electronic Measurement side are behind us. But, for the Life Science and Chemical Analysis side, it is still very significant run rate for margin expansion by reducing costs, is that fair?

Absolutely. We didn't even talk about the NMR. NMR has got all kinds of opportunities.

Right. Got it. Thanks, so much.

Thank you.

Daniel Silver, UBS.

Hey, guys, thanks for taking the question at the end of the call. And, obviously, I hope guys have a good day. Wishing you guys a solid time, walking through with investors all of the comms noise. So, just a few quick ones.

Just to clarify some things. First, following the comment that was just made about NMR. I think it's an interesting question there as it relates to the margin trajectory at BAM. At least versus my model, it was actually surprisingly strong. And, we think about CA, and what's going on in LS between the NMR investments, the varying cost savings, and the incremental targets.

It would be great if you could walk through how you think about how the year progresses in light of the costs. And, I would say before the COGS line. And, I've got a follow-up to that.

There's lots of parts of your question. So, let me -- I think the easiest is just for me to give an example of what we're going to do and then turn it over to Mike and Nick to be able to how we balance the portfolio. For example, in NMR, Varian invented the technology, underinvested, the other guys have done a very, very good job.

We are systematically going through and redesigning the consult. It's already transferred to Penang. Redesign the probes, try to optimize the magnet manufacturing, these are all the things and Nick, in his past life, was an expert in this space. Those are the types of things we're going to do. And, so, we have that impact to his operating profit number.

And, it's substantial. On the other hand, we know we can fix this. This is where the expertise of our of Electronic Measuring group comes in. Essentially, it's an RF measurement. And, we will do that and spend the time to be able to make that through.

So, Nick's hitting it incremental even though he's making this investment in NMR based on the benefit of the growth he has in the other products. So, that's the example of things we are trying to work through. And, that is consistent with our operating model that we have displayed and we will give an update next month.

But, again, we are really quite pleased with the progress we've made in terms of driving the top line growth as well as making these ongoing investments. As well as the impact of the acquisitions, which, again, is small numbers but are nontrivial. So, I'll have Mike and Nick give some comments.

Yes, Daniel, since that gave the NMR example, let me give you one more layered detail. I'll let Mike do the subtenant comment. But, just to think about this, you redesign a product, you also move the supply-chain. And, you redesign the new product to include a supply-chain that's based in leverage.

And, it goes back to what we're trying to do here, Ron talked about, and we'll talk about a lot more when we see you guys in March. Centralizing order fulfillment, centralizes our supply-chain. I get the R&D time to design a new NMR probe or a new NMR magnet or a new NMR console, and at the same time we leverage the supply-chain of a $7 billion company that's heavily Asia-based and rapidly Asia moving. That gets up front in the design.

So, all of these pieces interweave to really drive that gross margin element. And, the target is not to take the 10 point gap that was existent between Varian and Agilent and close that gap, the target is to take where Agilent will be in two years and drive Varian to that point. Which will be better for Agilent was by itself two years ago.

And, if I could just hop in for just a sec, I guess that speaks to the real crux of the question which is when we look at the incremental targets that you guys have provided by segment, it certainly seems like at least given what saw in BAM in 2Q -- excuse me in fiscal first, the run rate actually it looks, all things considered, like you guys are now above plan. Overall.

Yes.

And, it would be wonderful, Didier, if you could speak to the overall run rates. When we look at R&D on a sequential basis, versus 4Q, I mean, that number has basically stayed flat for a while now. And, SG&A barely budged. So, I guess when investors think about the flexibility that you've obviously demonstrated, right, with EMG having a very strong incremental in the quarter, how do these numbers directionally move through the rest of year?

Well, so, you can reconstruct that from the overall guidance I provided. But, yes, you will see as you do that BAM will have some really nice incrementals in the second half of the year.

Only comment I would make, Didier, is the integration is behind us. We're in pure execution mode. And, lots of things are going on relative to supply-chain transformation. As Nick talked about, the portfolio transformation.

And, for a few quarters, you are going to continue to see, you'll look back and you're going to see these reflective flow through systems in terms of continuing to improve our gross margin. So, pure execution mode.

Again, to remind everyone on the call, is that we have moved the company over the last seven years to have a higher and higher percentage of variable costs, variable spending. And, as we entered into 2012 we've raised the bar. Our goal, instead of 21% of return invested capital now is 25%.

We have set the pay for all the executives at a higher growth rate than what we just said. So, that obviously builds into the system lower expenses as we go forward. And, that's factored in our guidance and factored into our confidence of why we believe that we can, under the scenario that we gave, we can hit the midrange of our EPS guidance.

Yes, to give a high-level view -- and, you can do reverse engineering, all the numbers that I've given you. But, on the midpoint of our revenue guidance, which is a 5.2% revenue growth, will generate the company 36% incremental. Which, if you know our operating model, 36% corresponds to 8% revenue growth.

So, what is happening a lot of the Varian cost synergies are starting showing up along with the benefits of the new organization. So, this is the thing that adds fuel to the fire. And, explains why we are meeting the midrange of our incremental guidance even on lower revenue.

And, that really was the heart of the question. It certainly does seem like the savings are showing up and investors can actually see the leverage that you guys have talked about.

Thanks for giving me the opportunity to reinforce that point. Thank you.

And, if I could ask one last follow-up. I think, obviously given all the focus that we spent this call talking about Comm, the various end markets, it's interesting because if we go back a quarter we were all talking about the regional outlook and what was going on in Europe and how things were shaping up in the US as it relates to Academic and government. In this quarter, if my math is correct, it looks like Japan actually accelerated. Europe was a positive surprise.

But, the US and China were a little bit weaker than expected. So, how do investors think about the overall volatility given there is obviously product and market noise. And then, now it certainly looks like there's a regional overlay. It's hard to reconcile when you build it all up.

Like I said, there is no lack of signal and noise ratio in this quarter. We have lots of good news. A couple of surprises in there. Different regional shift. And, again I'm sure each of us on this call has a different opinion of what is going on.

But, this is the challenge that corporate America, corporations around the world have, of trying to navigate a pretty complex set of markets by region. And, submarkets that we have. And then, of course the performance of the company itself. So, again, I don't envy the investors in trying to sort out exactly what's going on.

Yes, I think everybody has to go, so we probably need to close this off for now. So, Keith, I'm going to go ahead and just close. And, thank everybody for joining us today. If you have any questions please, of course, give us a call. And, thanks again. Goodbye.

Ladies and gentlemen, that concludes today's conference. Thank you for joining us, and you may now disconnect. Have a great day, everyone.