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Executives

Bill Sullivan – President & CEO

Adrian Dillon – EVP Finance & CFO

Ron Nersesian – President Electronic Measurement Group

Nick Roelofs – President Life Sciences Group

Mike McMullen – President Chemical Analysis Group

Alicia Rodriguez – VP IR

Analysts

Deane Dray – FBR Capital Markets

William Stein – Credit Suisse

Jon Groberg - Macquarie Securities

Mark Moskowitz – JPMorgan

John Wood – Jefferies & Co.

Tony Butler – Barclays Capital

Mark Douglass – Longbow Research

Ajit Pai – Thomas Weisel Partners

Rob Mason – Robert W. Baird

Agilent Technologies Inc. (A) Q1 2010 Earnings Call February 12, 2010 8:30 AM ET

Operator

Good morning ladies and gentlemen and welcome to the first quarter 2010 Agilent Technologies Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to Ms. Alicia Rodriguez, Vice President Investor Relations.

Alicia Rodriguez

Welcome to Agilent's first quarter conference call for fiscal year 2010. With me are Agilent's President and CEO, Bill Sullivan, and Executive Vice President of Finance and Administration and CFO, Adrian Dillon. Joining in our Q&A will be the President of Agilent’s Electronic Measurement, Life Sciences, and Chemical Analysis Group, Ron Nersesian, Nick Roelofs, and Mike McMullen.

After my comments, Bill will give his perspective on the quarter and the overall market environment. Adrian will follow with his review of financial results and after Adrian’s comments, we’ll open up 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 web site at www.investor.agilent.com. We are also providing further information to supplement today’s discussion. After you log on to 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 will find on our website the required reconciliation to the most directly comparable GAAP financial metrics.

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.

As a reminder regarding Agilent’s pending $1.5 billion acquisition of Varian, given that the deal has not closed and we are still currently in the regulatory approval process, we will not be providing any additional details on the deal post closing integration, synergies, process, or cost savings. For information on the acquisition, we recommend that you review Agilent’s and Varian’s SEC filings.

Before turning the call over to Bill, I want to remind you that Agilent’s annual analyst meeting typically held in early December, has been postponed until March 2010. This will enable us to talk more freely about Varian and the integration at that time, pending regulatory approval.

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

Bill Sullivan

Thanks Alicia, and hello everyone. In a few moments Adrian will provide you with detailed analysis of our Q1 financial results. I would like to provide you with a summary of results, an overview of the market perspective, and our outlook for the year.

Agilent’s Q1 revenues of $1.2 billion were up 4% year over year while orders of $1.2 billion were up 9% from a year ago. Non-GAAP earnings were $135 million or $0.38 per share. Agilent’s first quarter earnings combined with solid asset management enabled us to generate $30 million of operating cash flow.

Q1 operating cash flow is usually negative or flat, however we ended the quarter with net cash of $1.2 billion. Agilent’s Q1 performance exceeded our own expectations and a very solid start for fiscal year 2010.

Several themes have emerged from this quarter that I would like to highlight, first all signs point to a recovery in most of our key markets. Second, Agilent has significant upside potential as a result of the recovery. Assuming a continued market recovery, Agilent will deliver 10% revenue growth and an earnings per share of $1.65 to $1.70 for the full fiscal year 2010.

In Q1 we are already reporting mid cycle operating margins of 15% and a 21% return on invested capital. The global recovery is being led by Asia and by China in particular. Excluding Japan Asia’s revenues are up 20% and China’s revenues were up about 30%.

Agilent’s continued ability to participate in a rapid Asian recovery bodes well as we progress into 2010. Q1 orders in non-Japan/Asia grew more than 25% year over year. This level of orders equaled more than 30% of Agilent’s Q1 orders.

The Americas and Europe has stabilized and were relatively flat over last year on a currency-adjusted basis. Our business in Europe is benefiting from a favorable currency exchange. Due to stabilization in America and Europe and strong growth in Asia we believe Agilent’s annual revenue growth will be in the range of 10% for fiscal year 2010 excluding the recently announced divestiture of our network solutions business and the future acquisition of Varian.

From a market perspective we saw year over year revenue growth in almost every key market. Our chemical analysis business had an outstanding quarter. Revenues were up 13% year over year with all key end markets up in double-digits. Food plus 17%, petro chemical plus 12%, and environmental forensics up 9%.

The team has executed very well and experienced excellent growth in GC/MS, and ICP/MS instrument platforms. In addition we had solid double-digit growth in our consumables business as well as excellent growth in our service business.

Our life science business also had an excellent quarter with revenue up 10% over last year driven by solid performance in pharma plus 8%, and continued growth in academic and government up 15%. The market acceptance of our new 1290 LC has been outstanding. Likewise we saw double-digit revenue growth in our microarray, reagent PCR, and informatic businesses.

Electronic measurement revenue was down 2% over last quarter but a dramatic improvement over the last four quarters. Industrial, computer and semiconductor markets were up 13%, aerospace and defense was up 12%, however this strong growth was offset by a 23% decline in our communication business due to the lack of demand for handset test capacity and again we believe this may continue for the next quarter.

Even more encouraging was the order growth of 8% year over year. Given our order growth in quarterly comparison to a very weak 2009, we are still expecting a double-digit growth for the remainder of 2010. We have fundamentally reset the operating model in electronic measurement, electronic measurement will deliver double-digit profit at a $2.4 billion annual run rate of revenue.

This year electronic measurement will deliver over 100% incremental profit. While the restructuring of electronic measurement has been painful, we continue to focus resources on major market opportunities and product solutions. We have entered 2010 in a very strong market position with a leadership position in network analyzers, spectrum analyzers, and a very strong product portfolio of oscilloscopes.

Yesterday we announced the divestiture of our network solutions business. This is the third divestiture we have made in electronic measurement group over the last year. We continue to make decisions to focus on our core electronic measurement capability consistent with the new electronic measurement group operating model.

Adrian will provide more details about the change in our electronic measurement group model during his presentation and the corresponding impact on Agilent’s financial performance. In summary we believe we’re in excellent position as we enter Q2.

As a result of maintaining our investments in R&D during the downturn our focus on differential technologies and new product introductions, and executing on our $525 million restructuring plan, we will be able to drive significant incremental profit as the markets recover.

For the second quarter of 2010 we expect revenues to grow in the range of 12% to 15% from a year ago. Non-GAAP earnings are expected to be in the range of $0.38 to $0.42 per share compared to last year’s $0.13 per share.

One final note regarding the status of Varian acquisition, we continue to work with Varian, US and EU regulators and potential buyers of the product lines to be divested. We have announced one of the divestitures and hope to reach definitive agreements for the other product lines as soon as possible.

We continue to be extremely excited about the potential [to] combination of two of the founding companies in the Silicon Valley. Thank you for being on the call. Now I’ll turn it over to Adrian.

Adrian Dillon

Thank you Bill, and good morning everyone. I’m going to offer a few overall perspectives on the quarter for Agilent, review the performance of our three business segments, and conclude with some thoughts about the outlook for Agilent’s second quarter and full year 2010. Then we’ll turn it back to Alicia for the Q&A.

Overall we are pleased with our first quarter operating results. The growth in orders and revenues suggest that the economic recovery that we first glimpsed at the end of Q4 has gained momentum over the past three months and that it should both broaden and deepen as the year progresses.

Our earnings performance demonstrates the power of Agilent’s operating model as our markets recover as well as the clear benefits of our $525 million restructuring program. Orders of $1.22 billion were up 9% from one year ago, and all three of our business segments were up from last year.

Revenues of $1.21 billion were up 4% from one year ago, with both life sciences and chemical analysis up double-digits and electronic measurement down only 2%. Geographically the star was non-Japan/Asia which was up 20% while Europe was up 6% in dollars and flat in Euros, and the Americas were off 2% from last year.

What is perhaps most remarkable about this quarter’s performance is that we hit our mid cycle operating metrics at the beginning of a new economic cycle. Operating profits of $181 million in the quarter equate to a 15% operating margin and our return on invested capital in the quarter was 21%.

We were also encouraged by our balance sheet performance, inventory days on hand at 93 days was 19 days better than one year ago. Receivables days sales outstanding at 47 were two days better than last year. During the seasonally weak Q1 we generated $30 million of cash from operations and ended the quarter with net cash of $1.2 billion.

In short we’re pleased with the performance of the company this quarter and excited to demonstrate what Agilent can achieve for both customers and shareholders in the years ahead. Okay, turning to the numbers, we had orders of $1.22 billion, up 9% from one year ago.

Electronic measurement was up 8%, life sciences was up 9%, and chemical analysis was up 12% from one year ago. First quarter revenues of $1.21 billion were up 4% from last year and up 1% excluding currency impacts.

Electronic measurement down 2%, life sciences up 10%, and chemical analysis group up 13% from one year ago. It is worth noting that as of the first quarter Asia at 36% of revenues is as large as the Americas for Agilent.

In fact excluding Japan, Asia represents about 26% of Agilent’s revenues and with first quarter growth rates of 20% non-Japan/Asia is clearly driving the company’s overall growth trajectory. First quarter gross margins at 56.1% were nearly two points higher than last year with electronic measurement up three points despite lower volumes and both chemical analysis and life sciences gross margins essentially flat with last year.

We have also maintained aggressive control over operating expenses. Compared to last year total first quarter expenses were down $39 million or 7%. Excluding currency the drop in spending was $55 million or 10%. And that includes $11 million higher variable pay than one year ago reflecting our better ROIC performance.

As reported R&D spending at $146 million was down 11% from last year and at 12% of revenues was down two points from one year ago. SG&A at $353 million was down 6% and at 29.1% of revenues was three points lower than last year at this time.

Operating profits of $181 million were up 91% from last year. The company’s first quarter operating margin was 14.9%, up nearly seven points from one year ago and as mentioned earlier essentially at our mid cycle targets.

Other income and expense was down $8 million from last year including an $11 million reduction in net interest income. Our tax rate during the quarter was 20%. Pro forma net income of $135 million or $0.38 per share compares to $0.20 per share one year ago.

Okay going from non-GAAP to GAAP, page four of our press release financial tables provides a detailed reconciliation from non-GAAP to GAAP income. Summarizing, we had non-GAAP income of $135 million. We had restructuring and impairment charges of $48 million, noncash amortization of $10 million, and $2 million income in taxes and other, resulting in GAAP income during the quarter of $79 million or $0.22 per share, compared to about $0.18 per share one year ago.

Turning to cash, as I mentioned earlier, DSOs at 47 were two days better than a year ago, and on a dollar basis were essentially equal to a year ago. Inventories on the other hand improved dramatically at 93 days, down 19 days from last year, $107 million lower inventories today than one year ago.

Total cash generated from operations was plus $30 million, during the quarter we had $25 million of CapEx. Included in that cash is $40 million of depreciation and amortization, and we spent $12 million during the quarter on acquisitions.

During the quarter we had $103 million of share issuances related to options exercises and our employee stock purchase plan or about 4.9 million shares. During the quarter we also repurchased about $100 million of shares or about 2.9 million shares. We also had about 1.4 million of share dilution from the increase in our share price during the quarter from $26.30 to $29.34.

We ended the quarter with 354 million fully diluted shares outstanding which ignoring the 1.4 million additional shares from the higher share price, is about 2.6 million more than we intended. There were more options exercises than we anticipated and for much of the quarter we were under 10B5 constraints and so weren’t able to respond to the higher level of operations exercises.

This quarter we will try to get the share count back down to 350 million, again ignoring the impact of the varying share price on the diluted share count. As mentioned earlier we finished the quarter with net cash and short-term investments of $1.2 billion, up $350 million from one year ago.

Okay, turning to segment information, as most of you know we redefined our business segments at the beginning of this year, and Alicia’s team has provided historical financial data for the new segments.

As a reminder we now have a revised electronic measurement segment which incorporates the prior semiconductor and board test segment and is run by Ron Nersesian. We have also split the old bio analytical segment in reflection of its increasing importance to the company into life sciences headed by Nick Roelofs, and chemical analysis run by Mike McMullen.

The press release provides a good amount of detail on the segment results and Bill earlier detailed overall market trends and so I will try not to be redundant in my remarks. We also have the three segment Presidents here and available for any detailed questions, should you have them.

What I will try to do is focus on the financial results by segment and give you a sense for our expectations for operating performance during the remainder of the year. Turning first to life sciences, this segment had first quarter orders of $336 million, 9% above last year and up 4% on a currency adjusted basis.

Life sciences revenues of $340 million were up 10% or 5% in local currency terms. Geographically the Americas were up 3%, and Europe was up 9% in dollars or about 3% in local currency terms. Japan was up 16% while other Asia led by China, rose fully 28% from one year ago. First quarter life sciences segment income was $55 million, up $11 million on a $31 million increase in revenues or a 36% incremental.

Gross margins were about flat at 54% while operating margin at 16% was up two points from one year ago. Segment ROIC improved five points to 21%. Looking ahead to the rest of 2010 we expect the first quarter momentum we saw to continue through the remainder of the year with full year revenues up 10% to 12% from fiscal 2009.

From an operating model perspective we anticipate a mid 30’s incremental operating margin contribution, similar to Q1’s performance.

Turning next to chemical analysis, we also saw a robust performance from this segment. Orders of $242 million were up 12% from one year ago and up 7% in local currency terms. Revenues of $244 million were 13% above last year and up 9% in constant dollars. Geographically the Americas lagged, down 3% from last year.

Europe and Japan were up nearly 20% while other Asia jumped 23% from one year ago. By the way it is probably worth noting that for chemical analysis, other Asia revenue at 29% is now larger than the Americas at 27%.

First quarter segment income of $67 million was $10 million above last year on a $28 million increase in revenues or a very attractive 38% incremental performance. Gross margins were stable at 55%, while operating margins improved one and a half points to 27.5%. Segment ROIC jumped 15 points to 60%.

Looking ahead we expect the recovery of chemical analysis markets to continue and to broaden across geographies. At this point we expect full year 2010 revenue growth of roughly 15% and consistent with Agilent’s operating model, a 35% to 40% operating profit incremental on that additional volume.

Finally looking at electronic measurement markets, we are seeing clear signs of a market turnaround that is beginning to gain momentum. First quarter orders of $642 million were 8% above one year ago or up 6% in local currency terms, the first increase in orders since early 2008.

Revenues lagging orders were down 2% from last year. Market trends were sharply bifurcated with industrial, computer, and semiconductor markets up double-digits but communications revenues still down 23% from one year ago.

Geographically revenues were down 3% in the Americas and Europe, Japan was very weak off 26%, while other Asia was up 16% from last year led by a 29% increase in China. Electronic measurement’s first quarter operating profit of $58 million was $64 million above one year ago despite $12 million lower revenues, clearly showing the cumulative benefits of the resizing of this business.

Gross margins rose by three points to 57% while segment operating margins improved by 10 points to 9%. Segment ROIC rose 13 points to 13%. Looking ahead electronic measurement’s $325 million restructuring program will be completed at fiscal mid year when we expect to hit a 12% operating margin at an annual revenue run rate of $2.4 billion.

We also expect the market recovery to continue as we continue to track the trend of semiconductor shipments with a one quarter lag. Overall we expect revenue to be up roughly 10% this year on an apples to apples basis excluding the divestiture of the network systems division that we announced yesterday.

Given the successful restructuring of this business we expect the incremental operating margin this year will be above 100%. Longer term as a result of the actions we’ve taken including shutting or divesting product lines that couldn’t achieve Agilent’s operating model, we expect this segment to generate a consistent 40% incremental operating margin.

Okay, finally, turning to the outlook for our second quarter of fiscal 2010, Bill mentioned that on a standalone basis, we expect revenues to be about 12% to 15% above last year and non-GAAP earnings to be in the range to $0.38 to $0.42 per share.

For the full year we now expect Agilent’s standalone revenues to be up roughly 10% and non-GAAP earnings to be in the range of $1.65 to $1.70 per share. These forecasts obviously do not include the impact of the Varian acquisition. They also ignore the impact of the network system’s division divestiture that we announced yesterday.

Assuming that the NSD transaction closes at our fiscal mid year, the impact will be to reduce our revenue growth this year by two points to roughly 8% year over year growth. The divestiture is expected to have no material impact on this year’s earnings per share.

More generally whatever the economic outlook for 2010 and beyond, our commitment is to deliver performance consistent with Agilent’s operating model, characterized by businesses that one, achieve an average 20% ROIC over the economic cycle. Two, achieve 30% to 40% operating profit incrementals throughout the cycle, and three, are cash flow positive from operations at every point in the economic cycle.

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

Alicia Rodriguez

Thank you Adrian, operator, please go ahead and give instructions for the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Deane Dray – FBR Capital Markets

Deane Dray – FBR Capital Markets

Just a question on the network monitoring business which arguably Agilent invented with its SSS systems, and to us long considered one of Agilent’s core businesses, so why is this no longer core and maybe if you could comment on any share loss over the past couple of years.

Bill Sullivan

Our core capability for 70 years in electronic measurement has been at the physical science level. We have been a leader in networks, spectrum analyzers, very, very strong competitors in oscilloscopes and the broadest range of electronic measurement instruments in the world. You are right that at the split with Hewlett Packard, this segment of the market became more visible through the work that had been done under Hewlett Packard even before the separation.

But our core competence is in physical science. This core competence is also what we’re using to leverage into our life science and chemical analysis market. I firmly believe that the company should continue to focus on its core competence and so making this divestiture, teaming it with a company such as JDSU that is really focusing in that area is better for our customers as well as for our employees.

And so I think it is absolutely the right decision for the company, going particularly given the direction the company is headed.

Deane Dray – FBR Capital Markets

Looks like Asia had a particularly strong quarter so maybe if you could provide more color in terms of specific end markets. China obviously did really well, what’s driving that growth. Is it, any color on what you’re seeing in communications, or food testing, is it related to stimulus pending.

Bill Sullivan

As Adrian noted we went through each of the segments per group, but China’s business is growing across the board in every one of our segments. Even in aggregate in electronic measurement even though [sell] handset test capacity is down, overall growth in electronic measurement in China was very, very good.

So that goes across all the industrial, all of the aerospace and defense, the semiconductor markets and again food continues to do very, very well, environmental testing, petro chemical, and the whole pharmaceutical area. So China is the story of Agilent and right now China is the story for the world’s economy.

Deane Dray – FBR Capital Markets

And then on your revenue growth assumption 10%, how much of that is organic versus FX. I guess the weak dollar helped a little bit so is your organic still 5% or is there any change there.

Adrian Dillon

For the company overall in the first quarter Forex was about 2% to 3%, we are assuming constant dollar from this point forward so on a full year to year basis it would be about 2% given that the dollar did drop over the course of 2009 but we’re not counting on anything material from here as far as the weakening or strengthening of the dollar.

Deane Dray – FBR Capital Markets

So basically organic assumption is slightly better than what it was last quarter.

Adrian Dillon

Considerably better.

Operator

Your next question comes from the line of William Stein – Credit Suisse

William Stein – Credit Suisse

Following up on the comments around the divestiture are there other parts of the comms test business or the general purpose test business that we might expect to see divested and can you give us an idea for what the strategic approach is going to be there.

Bill Sullivan

Sure, we had made three divestitures in the space, two of them around the networking space, the N2X platform that we sold to [Ixia], the network solutions division that we sold to JDS and we did shut down the optical and x-ray inspection business and so the ultimate divestiture we shut it down.

This will allow Ron and his team to focus on the absolute core competence that we have in our three major platforms and again, huge capability in all the accessories and programmable power supplies to meters and handheld instruments. Ron, make a few comments about the renewed focus that EMG has in your new operating model.

Ron Nersesian

Our focus is built around the physical layer and we have a strength of products throughout our portfolio that we will continue to focus on to achieve our top market position. For instance for the LTE market, we have electronic design automation software and then core physical measurement products such as signal sources, signal analyzers, network analyzers, and even a new product category that we invented, a base band product called the PXB.

All of these products together are the core of the company. They have produced the majority of the profits for EMG and we are in very strong market positions. We will continue to focus on these markets to exploit the opportunities that exist as well as to deliver at least a 40% incremental on additional revenue.

William Stein – Credit Suisse

And then just one more quick one, the restructuring, how much of that is left to achieve. In our model should we assume that after April we’re back to a normal 30% to 40% contribution for the whole company or do we start to see something that maybe for the July and October quarters is still a bit higher owing to the rebound that seems to continue.

Bill Sullivan

I’ll have Adrian give you the weighted average but we will continue that 30% to 40% increments in our chemical analysis and life science and you should assume that Ron’s business in EMG will have greater than 100% increment for the remainder of the year.

Adrian Dillon

To answer your questions, we probably have about $30 million of annual rate savings yet to go between now and mid year to complete the program in EMG. Because of the full year effects we’ll continue to look like we have very attractive incrementals in aggregate going forward.

The roughly, they’re in, they’re above the 50% range even after a year in the second half of the year, again because of the full year effects of what we did last year. But Bill gave the real story which is that going forward even after you’ve had the full year effects taken into account, we’re talking about a 30% to 40% incremental and with EMG being at that solid 40% high end of our operating model.

Bill Sullivan

And that was reflected in our earnings per share estimate and again assuming that we fully participate in the worldwide recovery.

Operator

Your next question comes from the line of Jon Groberg - Macquarie Securities

Jon Groberg - Macquarie Securities

Can you maybe just on the, I know you’ve had a few questions on this network divestiture, I’m just trying to reconcile what JDSU said about the business and how you seem to be describing the business and so they were describing it as having very high both gross and operating margins and then but you’re saying really not going to be meaningful to earnings. Can you maybe just characterize that business for us in a little bit more detail.

Adrian Dillon

I will not comment on what JDSU had to say, as we mentioned in the press release that it is a business that had about $160 million in annual revenues last year so about $40 million per quarter and that for Agilent it will not be dilutive this year when we divest it. And so you can come to your own conclusions about the profitability.

Bill Sullivan

Just look at the network business historically has had higher gross margins, a little bit lower operating modules versus the core business that Ron manages, and so overall there just won’t be any impact to our electronic measurement business as we move forward.

Jon Groberg - Macquarie Securities

And then just to be clear, big part of the story on the EM side has been this migration to 4G and a lot of people wondering trying to figure out where now you’re left in terms of benefiting from 4G, is it primarily on the handset side as new handsets are developed and then just on the R&D, or what other pieces of your business then are left to benefit from as you move to LTE.

Ron Nersesian

We’re benefiting from first of all the overall design of products such as cell phones and base stations on this LTE build out and as I had mentioned previously we make electronic design automation software which helps people design wireless products for the LTE and WiMAX build out.

On top of that we make signal sources and signal analyzers, other products that are used in early R&D mainstream R&D as well as in production and we’ve also added some installation and maintenance products that will allow us to capitalize in that area.

But we have over 15 different products in our LTE portfolio and we will capture a high percentage of the overall revenue and a good bulk of the profit from our focus on the core markets.

Jon Groberg - Macquarie Securities

You’ve often described the EM business as a [inaudible] quarter lag to the global semiconductor market, and if you go back and look at the correlation, there’s a very good correlation there. If you look at the coming quarter, your second fiscal quarter though over the global semiconductor market, just given the severe drop of a year ago, its looking like it could be a very big quarter, you’re guiding to a little bit less growth. Is that conservatism or is there something maybe we’re missing in terms of your particular benefit from this really easy comp that you get year over year.

Adrian Dillon

There may be a little bit of both but that’s a directional indicator, the correlation is about 90% but its more directional than it is take it to the decimal point on the annual growth rate with the one quarter lag. So it gives us a lot of confidence directionally that this business is gaining momentum but I wouldn’t take that correlation too literally.

Jon Groberg - Macquarie Securities

So over the second quarter specifically, is your visibility pretty good there or is there still I’m trying to remember on the EM side, I know a little bit more on the BAM side in terms of orders versus shipments in a quarter and the type of backlog you have, but for EM for second quarter would you describe your visibility to the guidance you gave as good or there’s potential for that to be much higher.

Adrian Dillon

The guidance is pretty good. We have an unusually high level of backlog at the moment and so I think that the amount of turns business we need to achieve the second quarter is unusually low. This is one data point for you and others, to the spirit of your question on communications remember that the NFC business represents less than 20% of our communications business. So as Ron indicated we have plenty of exposure and opportunity in 4G moving ahead and where it plays to our core, this network monitoring business was less than 20% of communications.

Operator

Your next question comes from the line of Mark Moskowitz – JPMorgan

Mark Moskowitz – JPMorgan

I was wondering if you could talk a little bit more about the book to bill ratio in your bio analytical business overall, it seems a little light. Is this seasonal and shouldn’t it be picking up a little bit more at least year over year trends given the easy compares.

Nick Roelofs

I’ll take the first part of it which is we are working off some backlog but the fair point of view remember that the life sciences business was not as deeply effected in Q1 of last year as the chemical analysis side of the business. So relative to our compare I think you’ll find that it is what you would expect in terms of book to bill.

Adrian Dillon

I’ll just give you a little color for the life sciences business the book to bill was usually below one in the first quarter. It was 0.99 in this quarter, it was also 0.99 a year ago at this time. So quite normal seasonality.

Mike McMullen

Very similar message on the chemical analysis business, had a very strong revenue quarter as noted, worked off a backlog we came into FY10 with, but we also continue to have strong robust orders which puts us in a good position which you see in terms of our forward guidance on revenue.

Mark Moskowitz – JPMorgan

And then can you talk a little bit about, it seems Agilent is moving from being an incumbent in most of the markets it plays to moving into more higher growth but yet in markets in which you have a lower share, can you talk about how this shift is going to change your sales compensation strategy or channel strategy as well as maybe your sales and marketing spend longer term.

Bill Sullivan

Well roughly 70% to 80% of our business in the company is sold through a direct sales force channel. The first priority is to have highly competitive products that differentiate ourselves in these new markets that we’re entering. We have been very, very pleased with the progress that we have made in our high end mass spec product offerings that we have had, a strong, I believe that the separation into two dedicated sales teams, one focusing on life science based customers and the other on the more traditional chemical industrial based customers will really enhance our ability to get the right skill set in front of customers to be able to explain, sell, and deliver on differentiable products.

The separation of our sales force between Nick and Mike has gone exceedingly well. Nobody has ever accused us of underpaying the market from compensation so I believe our compensation systems are very, very competitive and I believe with this very strong product funnel that we have with an upgrade in the absolute skill set and more importantly the focus of our sales teams will able to keep our momentum and a momentum that we believe is one of the strongest if not the strongest in the industry.

Operator

Your next question comes from the line of John Wood – Jefferies & Co.

John Wood – Jefferies & Co.

Can you give us some view on the operating free cash flow outlook for the core business in 2010.

Adrian Dillon

We will have a very attractive cash flow characteristics again this year and I would say its in the range of based on the guidance that we gave for the full year, its in the range of $600 million.

John Wood – Jefferies & Co.

And then the world trade piece of debt that matures, I know in early calendar year 2011, is there any potential to refinance that early given where the corporate bond markets are today.

Adrian Dillon

We do not have an early refinance option, but obviously we’re working with our partners there on deciding exactly what to do whether to refinance it, whether to extend it, or whether to pay it off. And we have the ability I think at this point to do any of the above and as the company has become recognized more and more as a very solid company from a credit perspective the value from having a secured facility like that does diminish.

So we’re looking very carefully at that. We have about another 11 months, but all options are available to us.

John Wood – Jefferies & Co.

And the strength that you saw in the pharma biotech business you saw in the first quarter is that, would you characterize that strength is all a function of the new product launches or has replacement demand for that customer base started to improve.

Nick Roelofs

We are seeing a bit of replacement demand because the pharma guys are just figuring out what they’re going to do. They had a reality that the patent cliff a year ago was a problem. They’ve come out of that. But it is primarily new product, new technology demand. And it is global. So we’re seeing a lot of relocation of pharma, adding equipment and capacity.

John Wood – Jefferies & Co.

Can you comment on the, any discernable impact you saw from stimulus either internationally or US in the bio analytical business in 1Q.

Nick Roelofs

Really our exposure to this is small, we are moving up our academic government sector so we’re at about 28% in life science group of exposure to academic government but our exposure is small and what we’ve seen to date is deminimous. So both comments one geographic point is that we did see some money flowing out of Japan and so if you looked at our detail that we posted for you you’ll see that the life science group did very well in Japan.

If you back the FX out of that most of the rest of that is Japanese stimulus. But again in a macro, this is a very small number relative to the life science group.

Mike McMullen

Just to add on, similar kind of story for Japan for the chemical analysis business as well.

Operator

Your next question comes from the line of Tony Butler – Barclays Capital

Tony Butler – Barclays Capital

China this morning announced I think for the second time in a couple of weeks that banks should increase their overall reserves thereby limiting the amount of money which can be loaned. While you’ve had tremendous growth in China, I’m just curious if the ebullience that you think will continue to occur there is also taking into account that maybe there may be some slowdown in the overall GDP.

Adrian Dillon

We were not suggesting that China was going to continue to grow at the 30% rate that we saw in the first quarter. We’ve been very surprised, happily surprised, and so the forecast that we’ve given suggests continued double-digit growth but low double-digit growth, not the kind of 30% you seen there.

Of course no one can ever predict with confidence what happens when banks tighten as opposed to raise interest rates but China has done a pretty good job so far of modulating that. No guarantees for the future but we’re pretty confident they will not overdo it and cause a sharp slowdown, we’ll see.

Bill Sullivan

And we’ve done a very good job of participating in the government infrastructure investment overall given our exposure and the growth of our analytical business in China. Hopefully a lot of our customers would not be, at least the order effected by any sort of change in availability of lending.

Tony Butler – Barclays Capital

Secondly on the gross margins for the EM business up almost 80 basis points sequentially, very strong, the question really is around if NSD is divested should we consider that going down or modulating or is there still room for some upside in that particular GM side of the business.

Adrian Dillon

I think you would be hard pressed to find the delta from the removal of NSD from EM’s gross margins.

Bill Sullivan

If you look at $40 million a quarter yes the gross margins are historically higher than the 57% but you’re going into the rest of the year where that team is going to deliver greater than 100% increments. I personally believe no matter what you assume on the operating margin or gross margin, that $40 million is going to be lost as we complete this quarter, the restructuring in electronic measurement, and the leverage that we believe we’re going to get.

Tony Butler – Barclays Capital

And then lastly you mentioned some comments around pharma biotech and the life science business, but I’m just thinking is this nothing more than share shifts among other companies and the growth that you see or is this really true growth in the total pies, is the overall market in the life science business growing.

Bill Sullivan

I think the overall market, is clearly growing. You’ve seen a lot of our competitors make announcements on their view of the market and I’ll leave it up to you to decide if we’re taking market share or not.

Nick Roelofs

I would just reiterate that we’ve seen a lot of information come out and a lot of clarity, I think the key issue there is growth here, everyone is seeing it and everyone is being pretty clear that there’s a growth opportunity in this space.

Mike McMullen

And just building on the commentary, really all of our key end user markets were up double-digit.

Operator

Your next question comes from the line of Mark Douglass – Longbow Research

Mark Douglass – Longbow Research

Good quarter, on the EM side can we talk about the used equipment sales, is that starting to abate inventory clearing out of the used equipment and a lot of this, the orders you’re seeing are for new products.

Ron Nersesian

We’re seeing obviously the amount of used equipment that we have we have been seeing that clear out and people asking for more and more new equipment. So there is demand there for used equipment but we have seen folks be willing to buy new equipment to get shorter deliveries even when some folks may prefer used equipment.

Bill Sullivan

And I’ll put a plug in for the team, we are a leader in used equipment. We learned our lesson from the 2000 downturn. Ron’s business which we call RSD does a superb job and you would be surprised on how well we do on driving incremental profit in this market, so we just have a great model and if we allow a customer to finance in numerous different ways, that customer can buy used equipment from us or the customer can buy new equipment as Ron said.

Mark Douglass – Longbow Research

And then continuing with EM, the shift to a greater percentage of distributor sales, what was that like in the quarter and then from a customer standpoint does it appear to be pretty seamless for them, have you had a lot of squawking about not having direct sales channel anymore to certain customers.

Ron Nersesian

No it is going extremely well, not only have we added more distributors to our overall channel mix, but we’ve also added Agilent technical partners and as we had gone through this restructuring many of the direct field engineers that we have in the company have moved to work for these technical partners.

So we have expanded our third party capability through this movement while retaining a lot of the talent that we have in focusing on Agilent products. And that of course gives us the focus that we want as well as it gives us the better variability in our overall cost model.

And these Agilent technical partners that we add sell exclusively Agilent products going forward. But overall the transition has gone very, very well.

Mark Douglass – Longbow Research

That’s helpful that a lot of them moved just to the partners.

Ron Nersesian

Yes.

Mark Douglass – Longbow Research

Just quickly what was the pricing in the quarter, if you can quantify it and are there any expectations for pricing in your guidance.

Adrian Dillon

There is expectations for pricing, and in the guidance and in fact price was quite stable across the past year.

Mark Douglass – Longbow Research

And then your CapEx for the year, last call I think you said it was 130 to 140, do you expect that to be a little lower at this point.

Adrian Dillon

Possibly $5 million lower than that sort of range given what we’ve done in the first quarter, correct.

Mark Douglass – Longbow Research

So $125-ish, $130.

Adrian Dillon

Yes.

Operator

Your next question comes from the line of Ajit Pai – Thomas Weisel Partners

Ajit Pai – Thomas Weisel Partners

Quick question I think on the manufacturing testers for wireless handsets, I think you talked about that still being weak and continuing to be weak in this quarter, can you give some color as to when you expect that to come back and what the driver would be.

Ron Nersesian

We’re continuing to see the overall wireless handset manufacturing be a smaller and smaller portion of our portfolio, not only on revenues but as we look at overall profit contribution from the industry. In particular we saw the, a lot of capacity be put in place in 2008 which is still now coming online and being utilized as we’re starting to see more growth.

We see growth obviously in low cost handsets for countries such as China and India and we’re also seeing Smart Phone growth in the higher end products. But most of the cell phone manufacturers whether they be contract manufacturers, or the original network equipment manufacturers, they have had enough capacity so are the results that we have talked about forward looking takes into account a let’s say a slower return to the manufacturing sector in handsets.

Ajit Pai – Thomas Weisel Partners

Right but let’s assume that you have a shift toward next generation technology as you’ve talked about increasing demand over there for some of your wireless R&D test tools, could you tell us whether there’s going to be any impact on the manufacturing side as well at some point when there’s a shift to the next generation, will there have to be upgrades to the equipment on that side as well.

Ron Nersesian

The exact rollout of LTE and the higher volumes for WiMAX, anybody can guess where that is based on all the forecasts of each of the players coming online. But we don’t see a very significant portion of LTE handsets being manufactured at all in 2010. So we’re continuing to see investments in 2G and 3G for many of the emerging countries and LTE and other 4G technologies will build up slowly through 2010 and beyond.

Ajit Pai – Thomas Weisel Partners

And then the next question, I think its been asked before, but just to ask the same question in a slightly different way, when you’re looking at the second hand market, or the grey market across your businesses, in the last slowdown there’s a pretty material impact on your sales for your electronic measurement group and it took awhile before your sales picked up even though the end market demand picked up awhile ago, now you’ve had unprecedented slowdown across most of your businesses early last year, now when you’re looking at things you did talk about the fact that you’ve got much better capabilities to sell used equipment as well and services along with that. But is there a dampening effect, are the numbers that you’re coming out with right now, would they have been much stronger if there was no used equipment in the market, how material is the used equipment in the market, both on the chemical analysis side as well as on the EM side.

Ron Nersesian

On the EM side its not very material at all. We obviously try to make the market efficient and really help get used equipment to keep players that do not want to buy or cannot afford new equipment. As Bill had said we manage that very well. We make a good return for our shareholders on the used equipment market but its not a big portion of the overall sales into any of these end markets.

Bill Sullivan

And on the analytical side we have not seen any material development of the used equipment market and again, we’ve been watching that very, very closely both Mike and Nick are very well prepared to emulate what we have done in electronic measurement, but again the used equipment market on the analytical side gets complicated because of the cleaning process, the decontamination process of the instruments, and so that just has not materialized and given that the market is recovering we don’t expect that to happen.

Operator

Your final question comes from the line of Rob Mason – Robert W. Baird

Rob Mason – Robert W. Baird

I wanted to see if your full year, just to circle back on the communications test business, does your full year outlook for EM or consolidated does it contemplate the communications test business being flat or possibly up for the year.

Adrian Dillon

I think what your question was, was the guidance that we provided for electronic measurements inclusive or exclusive of the NSD divestiture.

Bill Sullivan

No he’s talking about handsets.

Rob Mason – Robert W. Baird

Does your guidance for the full year for EM contemplate the communications test business being flat or up, I guess exclusive of the impact of the divestiture.

Ron Nersesian

Our guidance doesn’t expect a very sharp rebound in that business but we see that business leveling out as we look at Q2, we have a relatively easy compare and then going forward we see a slower recovery in the communications market relative to aerospace, defense, or industrial computers or semiconductor markets.

Bill Sullivan

One of these issues is that as we had such a low level and moving into easy compares doesn’t become material obviously if the market magically turned around, we’re prepared to respond. But that guidance does not assume any sort of dramatic improvement in the handset and as Ron said, its becoming a smaller, much smaller part of our portfolio.

Rob Mason – Robert W. Baird

Was the wireless R&D portion of the business, did it grow in the quarter.

Ron Nersesian

As Bill had mentioned that business was relatively flat this quarter but we have invested through the downturn to bring the leading edge products, we’ve just introduced the number one product category in the electronic test and measurement business is the spectrum analyzer business and we just introduced the world’s highest performance spectrum analyzers in the world which completes a brand new family of four series of products and we believe we’re in the best market position that we’ve been in in well over a decade in that area.

So the investments that we have made through the downturn and even as we have restructured have focused on where the key contributions are in R&D as well as in other markets. So we think we’re positioned very well for any type of rebound in that area. But we do feel very comfortable with our guidance.

Rob Mason – Robert W. Baird

And then just switching to the chemical analysis business, we tend to think of that as perhaps a little later cycle and your guidance for the full year suggests even more acceleration off a pretty good first quarter, just maybe comment where you’re seeing that strength. I think and specifically the European and Japan growth of 20% seems, was a little surprising just given the macro backdrop in both those countries but just a little more color on how you think chemical analysis plays out for the year as to what’s driving that.

Mike McMullen

We’ve seen really robust growth across all the core markets as mentioned earlier, I think this really is a, and what we’re well positioned to capitalize on that based on some of the decisions we took last year in terms of maintaining our focus on the new product investment pipeline as well as really staying close to our customers even when they didn’t have money yet at that time to purchase.

I think you’re seeing that pay off in places like Japan and Europe where they’re ready to buy and we’re seeing some recovery particularly in Japan as it relates to government money coming into the market.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Alicia Rodriguez

I’d like to thank everybody on behalf of our management team for joining us today. Please call our investor relations team with any follow-up questions you may have. We look forward to speaking with you and again thank you very much.

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Source: Agilent Technologies Inc. F1Q10 (Qtr End 01/31/10) Earnings Call Transcript
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