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Agilent Technologies Inc. (NYSE:A)

March 08, 2012 10:00 am ET

Executives

Alicia Rodriguez -

William P. Sullivan - Chief Executive Officer, President, Executive Director and Member of Executive Committee

Didier Hirsch - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Ronald S. Nersesian - Chief Operating Officer and Executive Vice President

Guy Sene - Senior Vice President and President Electronic Measurement Group

Nicolas H. Roelofs - Senior Vice President and President of Life Sciences Group

Michael R. McMullen - Senior Vice President and President of Chemical Analysis Group

Soon Chai Gooi - Senior Vice President of Order Fulfillment and Supply Chain

Rodney Gonsalves - Director of Investor Relations

Analysts

Unknown Analyst

Alicia Rodriguez

I think we should probably get started. I'd like to welcome you all, and thank you for coming today to Agilent's 2012 Investor and Analyst Day.

This is our Safe Harbor Statement. I know you are all familiar with it, but just quickly, included in there are our comments about forward-looking statements, also about risks. And if you have any questions whatsoever, please ask me or refer to our 10-K, 10-Q for further elaboration.

Okay. We plan to get you out of here by 2:00. So if we're successful, we're going to start with Bill and Didier giving an overview of our strategic and our financial update. We'll end at about 11:30 and break for lunch after that. Lunch will be here. Didier and Bill will have a Q&A session immediately following their 2 presentations. We'll start back up after lunch at about 12:00, just wanted to be sure on that. And then Ron, our Chief Operating Officer, will give an update on operational, different initiatives that you'll see. And then, we will go into each of the group presidents for EMG, CAG and LSG will give their updates, and we'll follow up with Soon Chai, who's our new order fulfillment manager, who is directing all of the order fulfillment operations for us. And I think this is something that's very exciting that you'll see. Last, but not least, we'll end with a panel Q&A for all of the different group presidents and our -- and Soon Chai, who I think will be able to offer you a lot of different answers to the questions that you'll have regarding what's going on with our markets, our operations and our plans going forward.

And finally, after that, Bill will close and then we'll all be off and it should be 2:00. So hopefully, we'll have a good day. And if you have any questions, just please let me or Elena know. We're both at the back of the room. Thank you.

William P. Sullivan

Good morning. Thank you all very, very much for meeting with us today. As you may recall a year ago, I was quite negative on the economic environment in the U.S. and Europe. Many of you in the room said that I was too pessimistic on the outlook, and I'm sure you all saw this morning that Europe will have negative growth. I wish I could say that I am any more optimistic in the U.S. or European economy than I was last year, we're not. We're also well aware of the macro environment in the emerging markets. And that's why our approach to the year, after coming after 2 very strong years, has been conservative, focused and really believe both our outward reach through our organic growth rate and our internal efforts to continue to drive our manufacturing cost down will allow us to navigate a very uncertain 2012.

Before I start though, I will ask the first question that I'm sure Didier and I will get and that is how were the orders in February? The -- I can share with you, the orders in February were off to a solid start for the year. We're not changing our -- or excuse me, for the quarter, we're not changing our guidance whatsoever. But again, the good news, as we stand here, is that the February orders were solid for the start of our Q2. In the area of Communications, we believe the Communications growth in the quarter year-over-year will grow. There has not been an improvement to date in the components, semiconductor component modules. For base stations, however, we will see growth in the handsets year-over-year. So that is sort of the recap as we've gone through 1/3 of Q2.

This is the organization chart that we have. Since the last time we have met, we have created the job of a COO, and again, Ron Nersesian. I think a lot of you know, but maybe Ron, if you could just stand. Ron now is responsible for the overall day-to-day operation of the company with particular focus on emerging market and to continue to drive our manufacturing cost, and of course, delivering ever better market-leading products moving forward. No stranger going from your right to left is Nick Roelofs in Life Science. Nick continues to do Life Science. And again, a very, very solid year last year. Mike McMullen, and again, that you've known from last year. And again, Guy Sene, who replaced Ron in terms of our Electronic Measurement Group. Guy used to manage the largest division in the company, our Sources and Spectrum Analyzer and our mobile testing. And Gooi Soon Chai, order fulfillment. All of the order fulfillment in the company now is consolidated, and again, to take the next step forward to be able to drive efficiencies across the company. Because at the end of the day, our manufacturing capability is really our secret sauce that allows us to make the R&D investment, allows us to make the investment in our sales and support organization moving forward. We are atypical. We own our manufacturing facilities around the world. Yes, we have partners in outsourcing, such things as PC board assembly, but we really do control our manufacture -- manufacturing throughput. We've done a good job. I know we can do an even better job moving forward.

Agilent Laboratories under Darlene Solomon continues. Again, we're one of the few companies that still has a central research lab. And I know Nick will talk about this, but our oFISH launch this week, what we call essentially SureFISH, that has gone out with an outcome of development from our central research labs. And of course, Didier is here from finance, which you know. Our HR and Legal, Marie Huber, where's Marie? Marie is right there, is our -- head of our General Counsel. Again, the corporate facilities and we continue to have centralized IT support and our real estate workplace services to get leverage across our worldwide organization moving forward. And again, our results in 2011, we felt were pretty good.

Last year when I was here, I talked to you about the transformation of the company. And if you had said that it was going to take 6 years to be able to complete the transformation, to be able to divest our semiconductor-related businesses, focus on measurement science, complete the largest acquisition in our history, Varian, I said it shouldn't have taken that long. We do have the excuse of a recession, economic correction in the middle of that, but it's been a lot of hard work. The message here, of course, for now is that we have had 2 outstanding years in a row, 2010, 2011. And in fact, 2011 was the best year in the history of the company moving forward.

In terms of the capital deployment, just like to remind you that since 2005, we have repurchased $8.6 billion worth of stock. Our share count is down almost 200 million shares. We've made about $2.3 billion of acquisitions in this period of time. And of course, in January, announced the first dividend in our history. The announcement of the dividend is actually very, very straightforward. We believe in this environment, an environment of very low interest rates, that people are wanting to have more return that was coming directly back to them. As you know, in the last 10 years, the S&P 500 has not done well. 70% of the gain in the S&P 500 in the last 10 years has been through dividends. And by us making this announcement, we are essentially able to broaden our investor base. And to date, and again, the date is preliminary, but today, I think it has been favorably received to do that. It's another avenue in our commitment to return cash.

Didier is going to talk into this, but we do still have a very fundamental problem of having enormous amount of cash trapped outside the United States. Last year, I was hopeful that there would be some sort of change in U.S. tax policy. That has not happened. The likelihood of that happening in 2012, I believe, is 0. And all I can say is please write your congressperson to see if common sense can prevail in Washington. The Silicon Valley has been very, very vocal on this with the enormous amount of cash that's trapped outside the United States with essentially the only alternative is to sit doing nothing or to invest in other countries other than ours.

This is a brief summary of the accomplishments in 2011. And again, financially, we are very, very proud in terms of our organic growth, our record EPS and our cash flow generation, as you can see on this slide. What I'm also particularly proud of is that even though that we have gone through essentially 2 years of 20% growth, we have not changed our fixed variable cost model. And I think that's a big takeaway and you're going to see that inside of Didier's presentation. Our commitment to make sure that we have flexibility to be able to manage through economic slowdowns, economic corrections moving forward. A lot of times, when a company goes through such fast growth, it is easy to add a lot of fixed cost. We were not able to do that. I believe that the team, the team that you're going to hear from today, is very, very disciplined on allocating resources to where opportunities are. So often in good times, you want to do something extra. You want to grow faster in Brazil. We want to grow faster in China. We want to do one more R&D project. It's just an add-on expense. And what you have seen and you will hear is that we are very, very disciplined in terms of reallocating resources to where there is opportunity.

Secondly, we continue through our global IT systems and our global real estate management systems to be able to drive efficiency across the company to ensure that we can, in fact, meet our incrementals, and again, Didier is going to give you an update on that.

I don't want to steal any thunder from each of the 3 groups. I will have a couple of comments. Electronic Measurement, again, has really been the big takeaway. And I talked about that several years ago, that under Ron's leadership, our Electronic Measurement Group made a fundamental change. We reset our operating profits at the bottom of the correction to 12% versus 0% in 2009. And you saw that happen. Not only were we able to drive the highest profits in the history of the company and the business moving forward, we also were able to drive growth. In that growth, particularly proud of the continued progress we have made in the oscilloscope market or time domain. As you know, that in frequency domain, our RF microwave business, we have been a leader for decades and decades and decades. We have not been a leader in the time domain regime. And we continue to make enormous progress.

The second thing I was particularly proud of the team is that we now have a very concentrated effort in module instrumentation. Quite honestly, we've been in module instrumentation for 30 years, but it has not been the focus of the group. The focus of the group has been feature-rich instruments that effectively have their own computer, have enormous amount of flexibility. And the reality is, is that the world does want, in fact, to have more flexibility with modular instrumentation. This will be a long-term, multiyear effort moving forward, but we're off to a great start and very, very proud of that.

In terms of the Chemical Analysis area, and this is where really is the story of emerging markets, where Mike's organization has just nailed emerging markets. Our ability to help out environmental testing, Petrochemical, Food Safety testing, as well as continue to maintain our market share and grow our solutions in slower growth markets in Europe and the U.S. is really a testament to the team moving forward and have just done an outstanding job while, by the way, integrating the vast majority of the Varian product lines. And we're starting to see the traction of our Spectroscopy portfolio that we have, and again, continue to be very, very excited as the team redesigns products and starts to have truly differentiable products in new product areas.

And finally, in Life Science. I've been very, very clear, Life Science has been the growth opportunity for the company that we have moving forward. If you went back, at 2005 we did not have a credible story in Life Science. Yes, we were very strong in QA/QC and Pharma, but other than that, we really didn't have the building blocks in genomics, proteomics, metabolomics and I'm very excited of the progress that has been made in that area. We continue to grow through acquisition, as well as organic effort. And for the first time, Nick will talk about our diagnostics effort. It actually will slightly show up on the radar screen. But again, we -- the big, adjacent market for all instrument companies in this space is the diagnostics market, the molecular diagnostics market. And again, we'll talk about that today.

However, as we move forward, again, the message, I'm sure every CEO tells you this, we're not resting our laurels. We're raising the bars. We went into 2012. The first one is that we raised our return on invested capital target from 21% to 25%. And again, this is a big deal, not only in just the mathematics of how it's calculated. Again, it's a pro forma calculation. It does not include our cash in there because it’s very hard for the team itself. Corporate basically decides what to do with the cash. But by doing this is twofold: one, it raises the bar to make sure that we continue to drive efficiencies in the Varian product lines that we have incurred, but every employee in the company's variable pay is tied to this number. So we have -- effectively have raised the bar for all 18,700 employees moving forward. And in fact, that factors into our cost model, both on the upside, as well as in the downside. Secondly, as I alluded to, and Didier is going to talk about that, this variable cost model that we were able to flex in 2009 and say $400 million is still there today. And again and again, Didier will go through that. And finally, in terms of acquisitions, I had talked about these $2.3 billion of acquisitions that we have made today, which has generated about $1 billion of revenue, and obviously, a little bit less than 70% of that is in Varian. But the message here is, and again, this is probably one of most go confusing things and the hardest things to understand how Agilent does acquisitions. There is only one brand, and that's Agilent. So when we buy a company, we buy a Varian; it gets integrated, all the same IT systems, many of you joke that on every one of our iPhones or BlackBerrys every morning, you get all the orders, you get all the revenue, by product line, completely automated. And we, in fact, do that. All employees are treated the same thing. All the Varian employees get a 10% raise because they're part of the Agilent Variable Pay program. And so we integrate them -- we integrate these product lines and the result of that is next to impossible to do what I say, measure the substitutions and the pull-throughs. And in terms of substitutions, we'll go in there, 2 products look the same, this one's gone; this is the one we're going to bet, shut it down and merge. So obviously, if that product kept it in the Agilent side, it looks like an Agilent growth. It doesn't look like the acquisition growth.

The pull-throughs are when you can put integrated solutions together or integrated service offerings. And what you're going to see in Mike's presentation is our service and support in the analytical space. Now that we have such a broad portfolio of analytical instruments, yes, we're in the process of redesigning a lot of them from the Varian side, now we can service all labs. And so what you're going to see in Mike's presentation is our services and support business is growing 17% because we have a different portfolio to be able to share with the customer. That's what I mean by pull-through. In terms of substitutions and how we work to integrate these integrations, again, Nick will go into a lot of detail of what we're doing, that only in the Life Science with the acquisitions that we have made on our organic growth rate but, as well as the diagnostics effort that we have made in the recent announcement that we have made. So again, we are still inherently an organic growth company. We do a very good job of integrating technology into the company, but it is quickly lost inside the one brand of Agilent as we go forward.

So in terms of our strategic focus, really hasn't changed from last year at all. Emerging markets, and again, I know that the issue of emerging markets, you’ll have lots of questions about that. In terms of the megatrends that we're focusing on, they're exactly the same. And you see them everywhere in the paper. We've talked about this for years. Again, the whole area of: healthcare, Food Safety, energy, environment and Communications. That is the story. And again, I think companies, particularly a company that is organically-oriented, organically growth-oriented, if we in fact are more clever, had better solutions that we believe we can continue to outpace the competition if we're more clever, and in fact, give better solutions and better customer support than the competition. So as a result of that, we're continuing to -- continue our huge investment in research and development. We will spend over $700 million this year in research and development. We have well over 6,500 people in our sales and support organization to provide the #1 service to our customers moving forward. And coupled with that, with our continued focus on gross margin, I believe that this is -- continues to be a winning play.

In terms of acquisitions, our position has not changed. We continue to look for value-added acquisitions that we have made. You can see that today, we paid roughly, in aggregate of about 2.3x revenue for those acquisitions. The environment for acquisitions in a lot of our spaces continues to be quite rich, but we continue to be absolutely dedicated to be able to protect our shareholders' equity and shareholder cash, and we'll continue to make decisions that are consistent to our operating model and the consistence of returning value to our shareholders moving forward.

So if there's any message that I started off is, is that even though there's enormous -- continued enormous amount of economic uncertainty in 2012, we believe that we are very well positioned to be able to capitalize on the opportunities on top of that. Secondly, the organization structure change we made, I think, is going to enhance our profitability to not only to win in the marketplace as I talked about, but to continue to drive efficiencies inside the company. I get asked that a lot. You guys have done such great job over the years of driving incredible, higher incrementals. And again, Didier will be able to show that. The reality is it can never be good enough. And this is a focus where you constantly have to look at how you provide the best measurement solutions in the world to our customers and how do we drive an efficiency of driving that solution to our customers. And we see that across the board, not even from our sales process or service process and our manufacturing process, but how we manage the whole company. What are the decisions of the infrastructure that we're going to put in to ensure that we can always be a leader when it comes to cost, not only being a leader in technology, which is our historical bias for -- since 1939. And again, I talked about the value for shareholders. And again, the big speed bump we have is this trapped cash overseas. Again, we can answer about questions about this to date. We're have not changed our position. We are not going to leverage ourselves up to be able to buy back stock. We want to be able to make sure that if we do, in fact, in the U.S. see an acquisition that looks accretive to the company, creates value for the company, that we do not use our debt capacity to do that. We've done a great job in Didier's team to become very well -- going from non-investment grade to BBB+ has been, I think, a real testament to the financial model that we have. And again, finally, I am very excited for you to introduce part of the team that you've known in the past, several players that you have not met, and of course, Ron and his new role as COO.

So with that, I'm going to stop and turn it over to Didier.

Didier Hirsch

Thank you. Thanks, Bill. Good morning. Thanks for joining us today. So I'm going to do a short survey of fiscal year '11 and '12, but we already talked much about it. The goal of my presentation will be to review the operating model. And I'll start with a refresher course of what is the operating model, what it isn't. Then, I'd like to review the operating model in action, which is basically the last 5 years, how well did we perform. And then answer a question that is often asked: why are we confident that the operating model is sustainable for the next 3 to 5 years? And then after I do that, I'll review the first year of the operating model in fiscal year '12. And then talk about the levers and answer also questions that we get asked often: What levers can we pool to perform in terms of incremental, decremental as per the operating model even in a soft economic condition? And then last slide would be around: where is our cash? What are our sources of cash, projected sources of cash? And what are our projected uses of cash?

So that's the high level. One slide on fiscal year '11, '12. Bill already talked about '11, a record year on many fronts, certainly in terms of operating margin, nearly 20%. Operating cash flow, $1.3 billion. Its revenue growth -- organic revenue growth, 17%. Last year in fiscal '10, it was 19%, on an organic basis, 17%. So really, a great year. Going forward, this is the guidance and no change in the guidance we have provided. You see the numbers for Q1. So basically, we are projecting an increase in operating model from 19.8% to 20.6% on 5% only organic revenue growth. And by the way, organic revenue growth is at the current dollar. So at constant dollar, it's -- you have to add 0.6%. It gets you -- it takes you to 5.8% above the 6%. So we call that core growth, which is at constant dollar. Organic growth is at the nominal dollar.

And then in terms of EPS, you know all the numbers. So we would reach an ROIC of 27% and operating cash flow around the same level as we achieved last year, where there was a little bit of exceptional positive. And all that is anchored on the consensus estimate regarding the world GDP growth of 3.3%. So some expansion which is basically going up a little bit in Q3, Q4. Hopefully, it will happen as the present consensus estimates. And the 3.3% is really a tale of many cities because it is Europe contracting. It is U.S. and Japan growing less than 2%. And then you have the emerging markets. In these assumptions, we've used China at 8.5%. I know this week the Chinese Congress presented a goal of 7.5%. I mean, it's been now for so many years that, in reality, they have exceeded their goal; who knows what they're going to do this year.

So the operating model. No change to what I presented last year. And so it is based on a goal to grow our revenue nearly 8%. And there, the most likely and most probable scenario between 4% and 12% for 2/3 of the outcomes and growing the expenses at a slower pace than we are growing the revenue. And now I'll talk more about why we are able to do that. And that, therefore, to deliver an incremental 36%, which is $0.36 of incremental operating profit for every dollar of incremental revenue. So it is a sustainable model throughout the cycle, an economic cycle, of 3 to 5 years. It depends on our ability to grow our revenue, organic revenue above 8%. I'll talk more about it, and obviously, all the group [indiscernible] will cover that also, and our commitment to grow expenses at a slower pace. What it is not is -- it is not exactly precisely the same model for 3 groups or for 35 product lines. Obviously, all those groups and product lines are different stages. They are facing different market opportunities. They are requiring different investments. And therefore, the 36% in an average for Agilent, it is not 36% for all of the 3 groups and all of the 35 product lines. And also, it is not for every model. It works very, very well on an annual basis. It is also a long-term commitment. It doesn't work as well on the quarterly level because there's going to be some volatility on a quarterly basis. And you have already figured that out.

So what have we done in the last 5 years? Well, we did meet the operating model goals. Our operating margins back 5 years ago was 12.9%. As you see below our peer group, and we were, clearly, in terms of operating margin, had a lower operating margin than the group's. This is where we are. We were last year 19.8% over the group's operating margin, and that has resulted in 40% incremental during this period. So very much aligned with our operating model. So that's the last 5 years. Question is, can we repeat it?

And the reason why we believe we can repeat it is, first, in terms of our top line growth, Bill talked about the significant investments we're making in R&D and our strong presence in emerging markets. We're an organic growth company, supported by strong R&D investments, and certainly, our very strong presence in the markets that are growing the fastest. That has been the key to our success. In terms of growth margins, for the next 3 years, we'll benefit from the continuing improvement in the gross margin for the Varian -- ex-Varian products. We still have $65 million of the $100 million that we committed to that will come out over the next 3 years. And then with Ron's and Soon Chai's appointments, we're going to leverage further the opportunities across the 3 businesses, the scope and the scale of Agilent.

So on the expense side, why are we able to grow expenses at a slower pace than we're going to grow the top line? It is due to the fact that certainly in SG&A, it's true and R&D also, the strength of our -- already our investments and the scale of Agilent and we don't need -- we don't believe we have to scale up the -- those investments at the same pace as with getting up the revenue. And then, Bill mentioned, he didn't call it global infrastructure organization, but basically, all the shared services that we have within Agilent, be it IT, workplace services, legal, HR, finance; those -- we built up the shared service organizations and we built the pipe in a way that it can really accommodate much bigger flows. So if you look at what we have done there in the last 5 years, we've grown the shared service organization's expenses by 6% over 5 years, which is 1% annual growth rate. And this is just through the power of that model where we have one large organization supporting all of the businesses. In addition, it provides the businesses an opportunity to focus on what is absolutely the key, but then it also provides the company opportunity to leverage the scale.

And then the alignment; the cultural aspect. The fact that, while we're so confident about the fact that we have 35 product lines with 35 general managers, they're all committed to their part, their piece of the operating model. And then the GIO organization is also committed to their piece.

So now, going into next year, same slide as the one you've seen before. We project to grow our operating margin from 19.8% to 20.6% which would be a 36% incremental on 5.2% organic growth; again, 5.8% in terms of core growth at constant currency. So basically, a better incremental than what we committed to in our model, where you get to 36% at 8% growth. We're not talking about 36% at 5.2% or 5.8%. And again, a better incremental than our peer group.

So a question that we are asked, "Okay. So we understand when things go fine, you're going to be able to deliver high operating margin incremental. What about if you hit a soft patch? What will you do? What are the levers?" And this slide attempts to address that question. As a percentage of revenue, it shows that 38% of our cost -- of our revenue, are variable costs and expenses. So there's a variable cost of sales, but there's also the variable Pay, the incentive pay, all the commissions, things that are variable in nature. And then on top of that, we have what we call flexible discretionary expenses of about 7% of revenue. And that would be things like temporary workers, outside services, travel, programs that we can delay for 1 quarter or 2 quarters without having much of an impact.

So basically, we -- 45% of our cost, we can -- of our cost -- of all cost -- of all revenue, I should just say, are manageable in case of a downturn and we have demonstrated that back in 2008 and '09, as Bill mentioned, not only did we leverage our operating model but also -- and we took further action, which we could take again if needed on fixed costs and expenses which can be scaled down. So it is not all thanks to the power of our operating model and our variable and discretionary cost structure. We went beyond that and we obviously don't see the reason to go beyond that today, but if needed.

Okay, last slide. Our cash position and our projected sources and use of cash. What is -- I shouldn't say specific to Agilent because there are so many companies now, at least in the Silicon Valley, who have the same situation. We have lots and lots of cash. But as Bill said, it is trapped offshore. In fact, at the end of October fiscal year, if you read the 10-K, there was only $100 million in the U.S., most of it was trapped offshore. Now we have $400 million in the U.S. Our net cash position is really good. We increased our net cash position by $1 billion from where we were last year. So we're very pleased. But this is a constraint that we have to operate within. And in terms of future cash sources, no chance for the free cash flow projection, so $900 million, about $1.1 billion of operating cash flow and $200 million of CapEx and about 15% of our cash is free cash flow. It's generated in the U.S. And about 10%, we can bring back on an ongoing basis from offshore sources without incurring any tax penalty. So basically, the 25% of our free cash flow that is available without incurring any penalty for our anti-dilutive buyback programs are our dividends, okay? About $250 million.

Now if we need more cash, where would we use it? Where would it come from? If it is cash offshore, obviously, you know where it's going to come from, from the $3.3 billion that is sitting offshore and increasing to the tune of $700 million or $800 million per annum. If it is in the U.S., we would borrow money to fund an acquisition that really generates value. So that -- there has been questions I've talked about, "Hey, why don't you buy back more shares? Why don't you do this?" This is how we would generate the cash for what usage we'd use it for. And we have no plans to grow the cash in the U.S. to buy back shares beyond what we are doing which we can fund through the cash we generate in the U.S.

And then priority use of cash, acquisitions. Again, the usual standard; they have to meet the strategic and return criteria. We do about $200 million per annum of acquisitions -- small acquisitions, either technology or bolt-on acquisitions. And then from time to time, we go with a large acquisition which we fund, if it is in the U.S., again, through debt. The second use of our cash now is dividend, $135 million per annum. And then the third use of our cash, which we intend to use it for that purpose, is our anti-dilutive share buyback program, which net-net of what we buy back versus what we get from our employees as the exercise option is about -- costs about $100 million in cash every year.

With that, I'll open it up to Q&A.

Question-and-Answer Session

Didier Hirsch

Who is the master of -- Alicia, do you want to -- Tony, go ahead.

Unknown Analyst

Question really to [indiscernible] when you think about something that you're rolling out, 35 managers, how much wallet share per customer for [indiscernible] in any one particular geography [indiscernible]

William P. Sullivan

Yes, it's a great question. And again, it's something I think each of the group presidents and Ron can talk about when they give their presentation. But the easiest way to grow is to take more market share of your existing customers. And that's really, for example, one of the reasons, I'll use the analytical side, where we did not have a full portfolio of products from just the box, the instrument side. We're very strong on the chromatography and the Mass Spectrometry side, but didn't have Spectroscopy, didn't have IR, obviously, didn't have NMR. And so by our ability, essentially to have more boxes in the lab is a huge advantage. That's one of the reasons we've been #1 in Electronic Measurement for decades and decades is that we have the broadest range of instrumentation in the world in Electronic Measurement. Today, we are second to none in terms of our analytical scope of products. So from there, you've got the instrument. In front of the instrument, though, and on the analytical side, is the whole sample preparation. How do you prepare the sample? How do you get the sample into the instrument? And then of course, how do you analyze the data once it comes out of the instrument? And that is where both organically and through acquisitions, we filled in all the pieces. We have our own robotics capability. We have our own reagent capability. We have all of our software capability moving forward. So as a result of that, once you have this anchor in there, the instrument, what can we do to take more value from the customer moving forward? On the Electronic Measurement side, of course, they also do that in software. And again, I know that Guy can talk about the amount of effort we have is to be able to provide additional analytical software tools on top of the instrument itself. Unfortunately, we haven't figured out how to sell photons and electrons in the Electronics side. And then after that, though, is the big service opportunity. There's something that sort of gets lost in the noise, but if you look at our service and support as a business, it is just huge. We are, we believe, #1 in service and support. And so aftermarket, and again, Mike's going to talk about this, now we can go into the lab and then manage the whole lab forum. And we've always had the capability to do multivendor. Now we have the capability of doing multivendor of which we actually have substitute of products on top of that. And so that is really the key, and you never ignore your key customers. The second part, though, is the emerging markets. How do you, in fact, get an infrastructure in place when economy is growing? And again, because of our roots, and I've talked about this in the past where David Packard had the first high-tech joint venture in 1983 in China, we know how to do that. We know how to build the management team. We have turnover rates that are half the industry at worst. We will put infrastructure in places. We put dental centers in, sales offices in every major city, local service and support. I resisted the big effort when everybody was going to consolidate all their service and support into India and let's have these big mega centers. The reality is, customers want service in their own language, in their own country. And so we have done that, and we’ve scaled very, very rapidly. Right now, and I think Mike just got back from Brazil, is how do we expand in Brazil? How do we take advantage of what's going on there in the petrochemical area? In the biofuel area? All of that area, what's going on inside the Pharmaceutical area? And so we also do it in parallel. But number one is how do we get more market share of our existing customer base, which obviously, is in the hundreds of thousands.

Unknown Analyst

Well, Bill, could you just talk for a minute or 2 about, maybe, the integration and the correlation between the product line managers in this GIO organization? It seems like over the last 12 months, you've maybe put more emphasis on the GIO piece of this and their ability to drive profitability versus maybe the product line managers prior to that. And does that play into the Varian acquisition? So maybe the question is, where's the biggest opportunity for profit?

William P. Sullivan

So the biggest -- I've said, if you look at the global infrastructure process, the first half with Varian is they had a corporate overhead that disappears, right? I mean, just the C-suite alone is $10 million, right? So you take their systems and then you migrate their systems onto our systems. And fortunately, they were on SAP, we're on SAP, and the team has done a great job of doing that. And so now Didier essentially has -- we have one ledger in the company, one ledger. And we migrate to be able to make that happen. IT, all the IT and the outlook and all the services and support all have to be integrated in. What is interesting is that actually costs us more money in some cases because Varian had pretty decent IT on a site that did not have big pipes between sites, where we have huge pipes between sites and we put those all in. So that's all the corporate issues moving forward. Legal, Marie's team puts all the legal together and do all the paper and we get that all done. And that was the $35 million in cost savings. It's relatively straightforward, not taking anything away from all the hard work, but it got done. The second part is where all the hardware comes in. And so for there, we have, and again Soon Chai will talk about that, is "Okay, what products are we going to consolidate to a bigger site?" And this just takes time. Moving spectroscopy from Australia into Penang. We're moving the RF consoles out of Santa Clara, California into Penang. Each of those, of course, takes a period of time to be able to set up a facility. Fortunately, we had an extra building in Penang that had to get outfitted and so we're in the process of consolidating manufacturing moving forward. Quite honestly, if you look at our manufacturing footprint, we have lots of opportunity, I think, to be able to leverage while still keep a very balanced geographical balance. We have not put all our eggs in one basket. And we've had -- we have factories in Europe, the U.S., Japan, Southeast Asia, China, and I think that balance has really helped us on dealing with some of the currency fluctuation that all of you have seen.

The third part of it is, is really the home run, is to redesign the products. And so the example that you had is, in terms of the world's first microwave AA, Atomic Absorption Spectroscopy instrument with a microwave, essentially a source. That's the type of thing that we do very, very well. What's going to be the next Optical Emission Spectroscopy, OES device that's going to be? What's going to be the next NMR? And the team will talk about that after the break. But that's really the secret sauce. Because you get a new product that's going to perform better and it's going to be manufactured at a lower cost. And so it's really a 3-stage process: corporate infrastructure, the easy things in terms of consolidation and then the new products. In the context of the new products though, procurement is the big wildcard. It's really not the labor arbitrage. And again, Soon Chai will talk about this is how do we buy as a $7 billion company and not as 3 groups? And again, each of them has done a good job, but now we've got advantage of procurement and logistics and all the rest and we'll talk about that after the break moving forward. So how does the product line interface with this? So essentially, they own all the marketing, the R&D and they go outbound through the sales force organization. Again, our sales force is highly integrated so that a salesperson in Agilent can represent the company. We can get those decisions made moving forward, then they would work with the IT organization, the real estate organization that reports to Rick Burdsall, who's our -- who is responsible for all of that. And then, they develop a plan to be able to make these changes. And we do that very, very well. I mean, we work seamlessly across the organization to be able to interface with the corporate organization to leverage our IT opportunities, to be able to leverage our real estate opportunities. And so we have one set of eyes instead of that product line manager only seeing his little world and say "Well, I'm in this state. And what can I do here?" By the way, there's 3 other sites that we can consolidate. We do the mapping on how long the drive is for employees and hope for us to make sure that we -- because we can do that in the center where the individual can't do it. And so we have a detailed list. Ron now would review all the opportunities to drive cost. And typically, if we can get a return within 2 years, we will execute very, very quickly. I've always been nervous on longer than 2-year initiatives on return. Didier and I go around that because people forget what the original number is. In 2 years, you'll get it done right away. So we really hope people to get these transfers done very, very quickly.

Unknown Analyst

So Didier, I think one of the most compelling, obviously, elements of the Agilent story is the operating model. So I just want to make sure, really understood what you were saying here. And what it is and what it is not. So you're talking about needing 8% core growth to get the 35%, 36% incremental.

Didier Hirsch

Yes.

Unknown Analyst

Yet this year, you're doing 5%, 6% core growth and getting 36%. So how do we think about -- has there been a downshift in terms of what it is that's necessary to get this, this 2,000 in fiscal '12, is this just an anomaly year because of Varian and other things? Can you maybe just help explain the dichotomy?

Didier Hirsch

Yes, we certainly -- if we see an opportunity to drive higher operating margin incremental at the said level of revenue, we'll do it. I mean, we just don't like to invest money short term if we're not sure that it is a sustainable pace. What happened, one of the things happened and Bill alluded to it is that as we raise the bar in terms of ROIC internally, all 18,700 employees and now everything here is being the same to get 10% Variable Pay, you need to achieve a much higher ROIC level. So everything else being the same, it leads to a lower Variable Pay year-over-year which is part of the reasons why this year, we are achieving more than our normal commitment. The thing is -- the second thing is on Varian. I mean the -- I talked about $65 million over the course of the next 3 years. It's like 2.5% for a year or something like that, so it is a little bit more in the first 2 years than it is in the third year. So that also is a positive factor.

William P. Sullivan

The third one -- the third issue has been -- I've been very clear. We're nervous about 2012. And this is the heart. So we've got this model that is 8% growth and 5% expense growth, right? So that's the model. And then all of a sudden you're saying, "Hey, Didier and Bill, that sounds great. You're growing a lot less. You're getting the same incrementals." Don't forget his slide, that the 45% of our total P&L envelope is variable cost. We can exercise the company to reduce cost instantaneously. We have all the systems in place. And so the first one is headcount. I approved every headcount and now Ron approves every headcount. We can turn the knob on variable cost overnight just by changing the AVP, which is our Agilent Variable Pay mechanism. It's tens of millions of dollars. So we have enormous flexibility and that's the part -- and I think that was -- a big takeaway of Didier's presentation is to realize that we had institutionalized that variable cost model and it's a huge part of the company. And of course, all the things Soon Chai is going to do, it goes into the part of the cost of sales variable part of that. But nevertheless, we have a knob that we can turn. And so then the question comes in, are we turning the knob too soon, right? Or are we giving up investments or not? And that's really the debate and the questions I would ask the team. Is Bill and Didier squeezing you guys too much moving forward? But we can -- instantaneously, we can cut it out. And the message in there, just like in 2009 when we took out $500 million of fixed cost and $400 million of variable cost, we still have that exact same flexibility in the variable side and you're seeing that happening right now. We are nervous about 2012 and we are only going to invest where we know that we can drive the business and we're going to guard down our earnings potential.

Unknown Analyst

We didn't believe you could grow 8% for the next 3 years, although you believe you could grow 5%?

Didier Hirsch

Back to the original, 2012 is...

Unknown Analyst

[Indiscernible] 35% incrementals in each of those divisions? Or are you...

Didier Hirsch

No. So on this 3, 4 years' basis; you have to go to the operating model. So you'll only get 35%, 36% as you grow 8%. It's not at 5.8% from the current percentage today. That is -- that's one year.

William P. Sullivan

Yes, the problem that you have is how long can you squeeze the organization, for example, on salaries. So the salary increases around the world, not real pressure in the Europe and the U.S., but China is going through the roof. And so let's say you assumed 2% or 3% salary increase. I mean, you just can't not do that. And so you will have some built up pressure that is going to be -- that's going to be worked out. So again -- but obviously, the messages in the short term, we can do exactly what you can say. We don't want you to model that in all the time because, obviously, we'll miss flexibility for the prudent investment that we think that we should be making.

Unknown Analyst

It would seem part of the reason that the model has worked is that you've been spending 10% of revenues on R&D. And yet Didier's Slide 14 seem to imply that you may get leverage, not only out of the SG&A, but out of R&D, i.e. that over time, maybe not this year but in future years, that 10% would drop. Is that really what you're implying, that you will get leverage out of R&D, i.e. that, that percentage would drop? Or are you thinking that, in fact, 10% is pretty much part of the secret sauce and you'll stick with it?

William P. Sullivan

Well, yes. Correct me, if I'm wrong, Didier said we get leverage because of our ability to share R&D across the organization. And we are enormous. I mean, at the end of the day, and I've shared this before, at the end of the day, there's a bunch of hard engineering work that's got to get done even in Life Science and Chemical Analysis and we're an engineering powerhouse. And so we do get leverage over there. Your model should assume that we are going to continue to spend that level of R&D at 10%. We actually do think that investment in our central labs really differentiates us. It differentiates with our ability to interact with academic research organizations around the world. On this SG&A, and again, we've talked about this before, and again, I don't want to steal any of Guy's thunder and Ron, but the one area we've done we have moved into an indirect channel in Electronic Measurement Group. Actually, one of the reasons I believe we've done so well, that actually puts more variability into our system, number one, plus, our biggest competitor basically owned that channel and now they don't. And so the -- and the analytical business has always had an aftermarket value-added reseller activity. Electronic Measurement, historically, has been much more direct, and our indirect sales now is higher. That gives us more leverage of our existing team, goes back to the original question, it allows our direct sales team to get more wallet share with the bigger customers, while we have partners to satisfy us with some of the more smaller customers.

Unknown Analyst

Bill, I want to touch upon sort of the concept you were just talking about relative to sort of flexibility of the organization, the nimbleness by which you'll sort of react to kind of global trends. One of the things we've seen in the last couple of years with the global economy is we've sort gone in and out of crisis at different times and the time periods in which that's happened have been relatively short. So it's made for managers, particularly high in CapEx businesses, a fairly tough landscape to sort of know when to pull back and when to sort of push on the accelerator relative to investment. And so I guess, if you're thinking about some of the parts of your business, I mean, are you more apt to get more aggressive in certain parts of the business versus others in terms of how you'll think about the cost structure and be reactive? And then two, how do you think about sort of what signs you're looking for in your business to sort of say, "Well, this is probably not something that is necessarily temporal. This might be structural or this might be a 6, 12, 18 month trend, not a 2 month trend." Because there's been a fair degree of variability in some the subsegments to where sort of that level of reactiveness, I think, is sort of challenging.

William P. Sullivan

Yes, that's a great -- it's a great broader question. So let me get at a high level. I mean, that's basically what the group president, Ron, the group presidents, Didier and myself, that dialogue of these macro-environments is really key for any company.

The closer you get to the customer and the company, it's harder to see the impact of variations moving forward. And again, you've heard me joke that in November of 2008, every CEO in the world stopped spending money. And I knew that was coming, right? Because I visit all the CEOs in the world and we talked about the exact same thing. Silicon Valley, 4 times a year, we all get together, hey what are you seeing? So you're trying to read the tea leaves in terms of being able to do it and as a result of that, you make decisions. And so the question comes in, in 2008, where we said, "Look, all hell is going to break loose," and we slammed that dial down and we are lucky we did it sooner than the event said and we were really lucky. Right now, we're in the fine-tuning one. And I had that Didier make a comment. I'll give an example of that. What's going to happen in Europe? So the Anglo-Saxon view is, it's a disaster and these guys will never figure it out. I have advantage with Didier, he is telling me that French and the Germans are actually going to figure this out, and don't worry so much, right? And so, we go through this dialogue inside. Fortunately we have the IT and measurement systems where we see every deviation. We know when the funnels are going to move. We know exactly, if orders -- all kinds of signs go up. All of a sudden this PO's got to be approval by the CEO or CFO. All kinds of bad news and that starts happening. And it's fortunately, we have quite a bit of analytical capability, but the end of the day the judge of the team that you're seeing today is when do you turn that knob and how do you control it. And we're actually quite, we're actually to date, knock on wood, we've been good. And I give a lot of credit, I'll put a plug in for Ned Barnholt , the first CEO, going through enormous terrible economic time, continue to make the IT investments to allow us to have the data to be able to help do that. And Didier, I want you to go show, I know you spent an enormous time thinking about this.

Didier Hirsch

Well, what I would add is install the cultural aspect, it's not like we see the TV the C suite and we give command control organization. We hit the panic button and then everything stalls and then, if we are wrong then we'll have to release the spending. It's really within the steady 5 product lines that most of the work is done in terms of [indiscernible] the softness or rubbish-ness of the market, and taking actions are wrong the kinds that you and I talked about. Controlling hiring, controlling decision expenses and all those kinds of things. So it is, we look at it some of it in the C suites and make sure that's it's total alignment, but a lot of the work is done by the folks of down in the trenches who really have, lot of visibility on what's going on within their business organization. And what we have seen, I mean, this, in Q1 is, and that's, we are a very diverse kind of organization where some of our business were at 14%, and others were down. So there are some of the things we can do at a companywide level and we will do and we have done in 2008, '09 and other things that really are better implemented at the division level, and the beauty of our decentralized structure is it allows in fact both.

William P. Sullivan

And the last thing I would put in is our compensation system is actually tied the results. Again, you just look at my own, you can look at all up. Only 10% of my pay is fixed. Everything else is tied to the performance of the company and to the Agilent operating model. At my fixed salary hasn't changed in years. The Board of Directors is absolutely committed to have a pay system that really holds myself and this team absolutely accountable. And so they're, I mean it's and it's real obvious, when you turn that knob, you know exactly what the impact is to the company, the shareholder and one's personal pay.

Unknown Analyst

Can I add, so one quick follow-up to that one point. I just want to --

William P. Sullivan

Yes.

Unknown Analyst

The whole portfolio theory that you sort of can have different pieces, sort of up or down and on average you'll kind of get to a growth rate, does that hold true for China as well, given its more of a centralized purchasing organization in terms of the country or do you see sort of more -- do you see, more or less, correlation in terms of the global demand at the specific demand in that region across all the various businesses? Just sort of curious if it has a different trend...

William P. Sullivan

I don't think that's the case in China. China, you have an Environmental Protection Agency. They make their decisions. The food industry, the Pharma industry, obviously, the big electronic accompanies all make their own decisions. So it's really -- it's not that different than the U.S. Yes, more command and control, but they have the same politics behind, you just don't see it on TV and actually, most countries are organized very similarly to the United States. In fact, the Departments are often called the exact same thing. So again, there isn't anything, I believe, fundamentally different in China that you would see here.

Unknown Analyst

Just a quick question on the mechanism that -- and the strategy behind the share repurchase program, which is designed to, as you put it, offset the dilution from the issuance of restricted stock and stock options. The -- and as a measurement company, it's all mathematics that the stronger your strike price is, the more shares you would have to repurchase to offset the dilution. It's a mechanism to ensure that you get the worst possible price, and the most of it as -- because the stock price then therefore dictates how much you buy. If our firm did that, we'd be out of business very quickly. How does a company that is so tied up in the precision of measurements institute a program that seems to be designed to give you the worst --

Didier Hirsch

I can guarantee something. It's not our buyback program that drives the share price, that's for sure. But, yes, I mean, that it's true for to a much bigger extent, to any. I mean, 2 companies that are even in the market, buying even more and more stake. That's what everybody had seen is that this mechanism creates a situation where companies basically end up buying more when the stock price is even at a higher level. Then, so our -- we do it to such a minimum expense. I mean, again, it is an anti-dilutive program. It is not...

William P. Sullivan

You describe it, Didier, you go through your own process. You come to me based on the analysis of valuation, is it a good time or not to buy, right?

Didier Hirsch

Well, we do that, but we still we didn't -- over a certain period of time, we like to be buy at, we bought at 1 million shares at $36, we're pretty, well, $34 in Q1. So that was pretty good. But, Dwight [ph] , you're right, over a long period of time, we may be forced to buy at prices that -- ECD's above the fair value, we probably, we'll discuss it at length, but that, so far, we're okay. And we do it up to an extent which is much less than a lot of other companies that I don't, I cannot understand why they would keep buying shares. So I understand the phenomenon, and I think we managed it pretty well.

William P. Sullivan

And to date, all of our purchases have been, is still a good deal. Our stock repurchase has been a good deal for our shareholders over time, and a lot of companies can't say that.

Unknown Analyst

Because the lower the option overhang is, the less of an impact the stock price will have on the diluted number...

William P. Sullivan

Absolutely. Your point's well taken.

Unknown Analyst

First a question for Didier, which I think's a quick one. And then a slightly longer one for Bill. As the company's built today, meaning, if you were to do no material acquisitions over the next few years, where do you start to feel like you've pushed the limit of operating margin improvement? I guess essentially what I'm getting at is a mid- to high-20s peak margin company as it's built today?

Didier Hirsch

Yes, I mean, it's a fair question. It's back to the question about are we starving the business and are we investing enough into R&D and these kinds of things. So I think we certainly look at it very, very carefully. We think that we do have, still opportunities because of the leveraging of our order fulfillment organization because of the Varian thing, so we are talking about the next 3 years, 4 years, 5 years.

I don't know beyond, there's probably a point where it will be, would be shooting ourselves in the foot if we would just go on, because our model, basically on 8% organic revenue growth implies 1 percentage point increase in operating margin every year. So that kind of go ad infinitum, right?

William P. Sullivan

We feel very good about the next 3, 4 years, and...

Unknown Analyst

And then, Bill, at the begin of your prepared remarks, you talked about you were pessimistic at this meeting last year and at least in terms of the outlook for the U.S. and Europe, that hasn't changed a lot. But at the time of last year's meeting, there were 3 big concerns, broadly, double-dip in the U.S., Greek default in Europe, hard landing in China. Seems like you should at least feel relatively better about things than maybe we did a year ago? And I guess the question is, one, is that the case? Two, how does that change how you think about managing the business this year versus last year? And I guess the bigger question, how do you make sure in these ups and downs, going back to Ross' [ph] question that you're not just managing for this year or next year but you're not starving the R&D investment that you want the making for 3 or 4 years?

William P. Sullivan

I think it's fair from going forward, giving this and again, I joked about Didier's convinced me that Europe will figure how to continue to kick down the can. China, of course, whatever they say, that's what they're going to do. And so you got some moderation there and the U.S., actually you could argue, so it looks a little bit better than what we saw last year. And in fact, there's no evidence of double-dip. So from that macro perspective, again, I'm nervous as could be. I tend to be conservative in this area. So as a result of that, but there are any outside of Europe's situation and the big glaring issues outside the Middle East, it's the latest one actually, which is that comes up is always out there, I believe that it will have a major impact. But right now, it's, I think the world is going to muddle forward. As a result of that, we have not made any substantive cut back on any of our research investments at all. And again, many of you know I spent 10 years in research and development in Hewlett-Packard and so I'm highly biased towards the R&D environment and so we have made no cutbacks there. We have made no cutbacks whatsoever in terms of our investment in emerging markets. The big wild card we have though is our gross margin, and I've said, we got 5 points there, right? And you saw Mike's numbers last year. She's up a point of that, right? So we've got these -- we have 5 points just to get back to where we were pre-acquisition. And that's a big number. And so as we think through our investment strategy, okay, the overall economy's sort of going to be okay. We're going to continue these investments and we got this wildcard and continue the gross margin improvements to offset any -- offset any surprises that are in a reasonably manageable range.

Unknown Analyst

Bill and Didier, could you discuss your acquisition strategy, maybe elaborate it on a bit, it seemed like it's a prevalent theme of your discussion, although organic growth is clearly your focus, it seems like it's come up more than I would've anticipated. Maybe is there a higher motivation in 2012 are there things you're seeing maybe on valuation that more attractive, or could you also discuss kind of priorities again, remind us kind of the types of products or geographies where you'd be most it, shouldn't go in, and then finally in terms of sizing, while your history has been kind of smaller bolt-ons, with the Varian deal, is there any size limit we should think about, is in fact that met your kind of return and strategic parameters?

Didier Hirsch

Yes, that's a great question. I'll let Didier talk a little bit about where we think about easily debt capacity is to maintain our investment grade and kind of sizes where the acquisitions are x non-U.S. acquisitions, because we have so much cash overseas. Our, continue to focus in our Life Science business opportunity moving forward, continue to believe that is the biggest growth opportunity that we have in our company, we have a unique capability, given our engineering strength and our chemistry strength and now the biological strength that Nick's next team has been able to build, is just a huge market, and we're relatively small market share in there, moving forward. For example, we just made the Halo acquisition in Sweden. And again, it's right outside of Stockholm. In fact Nick and I were there a couple of weeks ago. Great team, another addition to our gene partitioning product offerings and again, Nick will talk about that. So we will continue to look for those opportunities. Sac I, again, is supplied markets. Mike will talk about the applied markets, where in terms of some of the portable devices in IR, for example, and we've made some acquisitions there. And even in Guy’s space, we just bought a software company in the wireless area, I think that's in California, a Chinese-based company. So we are going continue to look for these opportunities and we actually integrate those very, very quickly. In terms of a broader acquisition in this space is the big issue of course is just the valuation. We are committed to return value that should be that the minimum at our cost of capital in a way that we – it’s not going to destroy our ROIC target moving forward over a period of time. And quite frankly, some of the deals are going down, basically right now, 6x to 8x revenue. And it's really, really hard to come up with a return number, right? Moving forward, and we are still committed to be able to make that happen. The final comment though is trying to get more reoccurring revenue. This is in service and support and consumables, both reagents as well as all the other types of stuff that we do in columns and supplies and all the rest. Because if we can get the mix change on the company, it's going to take more volatility and increase the margins. And in fact, goes to the previous question about can we do better on this 20% operating model moving forward, the answer is yes. The biggest driver, though, would be a more shift to recurring revenue which just inherently has higher gross margins. Didier, in terms of our debt capacity and deal capacity, U.S., non-U.S.?

Didier Hirsch

Yes. Well, non-U.S., you've seen it's pretty large. In the U.S., I mean, we are determined to maintain or even improve on our investment grade rating, and right now, we have the main reissue is that to EBITDA, we have debt to EBITDA of 1.5x, 1.6x. Clearly, below kind of under what it's really, it's required to have the kind of investments grade rating that we had. So we could, assuming a good EBITDA from the company we acquire, we could certainly grow $2 billion to $2.5 billion easily and maintain our investment grade. Not that it would not damp our EBITDA over 2, for a certain period of time, perhaps 1 to 2 years. But with a clear plan to go back to 2 and below 2. So that's how we view things with the U.S. debt.

Unknown Analyst

Okay, so I think the capital as a point of strategy is pretty clear at this point from a near to intermediate term. But Bill, just what you feel like you're options are longer-term, to address the foreign cash issue because you're still building an awful lot of cash for, outside the U.S. So longer-term, 3, 5, 7 years out, how do you address the fact that the most of your cash is going to be overseas?

William P. Sullivan

Yes. I still continue to believe, and this may be completely delusional, that common sense will eventually prevail in Washington one way or another, because I mean again, as you said, 3 years from now, we're going to have what, $7 billion of cash sitting overseas moving forward and so right now, we still believe and again, the Silicon Valley is -- a lot bigger companies than us have been very aggressive trying to encourage Congress to move forward. But the underlying assumption that we have is that there will be a change in the, on the tax policy and deferral moving forward. If not, we have a high-quality problem to am [ph] , but then we're just going to have it to deal with that when that comes. But as it stands now, I think '12, not going to happen, depending something hopefully will happen at '13, '14 range, then after that, you guys are going to be asking us all kinds of questions, given the amount of cash that we'll have accumulated overseas.

Unknown Analyst

I guess related to that, when you look at a foreign asset, meaning you wouldn't have to pay the U.S. tax repatriate, I mean, does that factor -- how does that factor into your hurdle?

William P. Sullivan

Well, we know that that's the case. It's a very easy, I think, for a management team to talk themselves into this. It's even worse, not only you have a 35% tax, but the money has no return. So everything is accretive, right? You get a double whammy, you don't pay the tax, and then it's automatically accretive. If you assume that this money will have no return forever, which also, I think, is an unfair calculation. We are a very disciplined company. We can do the exact same calculations everybody, but I'll tell you, between Didier and myself and Ron and the team, to make up something in the short-term and ignore basic economics, we're not going to do it.

Unknown Analyst

You -- can you sort of just talk a little bit more. I understand that acquisitions are difficult but between this ROIC of 25% plus and the cost of capital, that's a wide range, I assume. But how do -- I mean, what do you think cost of capital is? And what do you really look for?

William P. Sullivan

Again, I had said that 25% return on invested capital is a pro forma number, the cash is not in the calculation. And some -- a lot of you figure that out. I said, "Bill, why don't you put the cash in a number to help you drive more return?" So remember, it's a pro forma number. And we deliberately did that and Didier has all the modeling. The cash and the volatility decision the upper management to do it is too volatile to explain to anybody, and so, remember our 25. You go back and recalculate our true GAAP ROIC is.

Unknown Attendee

Let me.

William P. Sullivan

Then I'll have Didier comment. So we have a number, our cost of capital is 9.5%. We make an acquisition over a reasonable period of time. We expect that acquisition with the add-ons, and the pull-throughs, and all the value added, that we in fact would not degrade our pro forma ROIC target over time. And you saw that, even with the issues with Varian. We in fact are raising the hurdle. I mean we are, we're making progress and we will continue and we find that a very effective way to drive focus in the company, and now, Didier.

Didier Hirsch

Yes, the ROIC is a snapshot of one point in time, obviously, because with a been an organic growth company, we have everything else in the same higher ROIC than folks who are purely buying at 6x revenue. But when we look at an acquisition, we look at, like everybody else, net present value, the internal rate of return and compare the internal rate of return to our work of 9.5%, 10% and based on that. And then, we do expect, then you have another thing is, we do expect that after 4 years, 5 year, whatever, that acquisition will return the ROIC, which is again, is the picture at some point in time, it's not a dynamic number. It is a picture at some point in time of the return on the investments to be about what the rest of the company is.

William P. Sullivan

You could see that we bought back $1 billion of revenue at $2.3 billion, and our ROIC is at a record high. So in aggregate, we integrate these very, very well from an outside view and I know you can't see the pieces of all this, but from an outside view and we do drive value from the acquisitions we have made.

Unknown Analyst

I just wanted to ask you about organic revenue growth potential going forward. The model highlights clearly the enormous sensitivity. So the faster you can grow organic revenue, keeping the economy inside, the more value you're going to generate. You've had tremendous success in areas like siliscopes in recent years. Can you walk us through as you look at the next 1 to 3 years, what are the areas that you're most excited about that could, that it will allow you to achieve the 8 or potentially do better than that?

William P. Sullivan

Yes. That's a great question and I'm going to be relatively brief answer because after the break, that's exactly what you're going to be hearing about, what we are doing in that area. But in terms of the communications, Guy's going to talk about the broadest product offering in history in the whole communication space moving forward. Obviously, the leverage of Mike's portfolio across all of these hot markets in terms of food, environmental, again, a whole slew of products and again, for us, the big long-term one, even though we're not at the operating model yet, is our ability in Life Science and we will give you the first exposure to what we are doing and likely diagnostics. And so that's kind of the flavor, but I don't want to steal any of the thunder from the guys after the break. But you can ask them all the hard questions that you want.

Unknown Analyst

A lot of questions on cash, what's available in M&A. So I guess related, but hopefully easier. When investors think about the longer-term earnings power, one of the things that obviously plays in is the tax rate and if we look at where Agilent was, say 2, 3, 5 years ago, where you are now, consensus seems to suggest that the tax rate actually is going to increase a little bit over the next year or 2. Generate a higher percentage of sales overseas. Obviously, a nice deal in Malaysia. How should investors think about the trend there as it relates to earnings power?

Didier Hirsch

I certainly invite you to use the 17% for your model. But our business model is such that the more profitable we are, everything else being the same, and obviously assuming no change in the tax regime, our tax rates will come down and this is what has happened in the past. We're still waiting this year for a renewal of the R&D tax credit, which could have also a positive impact on the tax rate. When we make acquisitions, and like Varian, and we integrate them, as we integrate them into our business model, also we benefit from a lowering of the tax rate. So those are the kind of the factors, but the best, I think is, to in your model to use 17%.

Unknown Analyst

So as a follow up, if the Varian integration enables a little bit of a decrease in the tax rate, now you're at 17%. If we assume there are either their normal course bolt-ons, et cetera, looking out 2, 3 years, right, as sales continue to grow outside the U.S. with the tax rate trend lower than 17%, if that's the base right now?

Didier Hirsch

Directionally, the higher our profit, the lower the tax rate.

Unknown Analyst

Maybe just a, following up on the questions earlier because the swing factors to organic growth. As we think about the business today, can you talk to where you think you got the greatest visibility going forward? And are there things that you are doing to improve visibility in areas like communications where things slowed down this last quarter?

William P. Sullivan

Yes, I think that in the short term, we have very good visibility of what's going on in terms of our order funnel process that each of the group presidents has sales teams. So we know what's going on. The problem though, because 75% of the company is capital equipment, the decision to change that reflection point typically is not the person that you talk to. And that's where -- that puts the uncertainty. And so for example, on a classic one in cellphones, right? Well, everybody, thinks they're going to take their own fair share of markets. They make this a big investment. Some win, some lose, you get a correction moving forward. Another company, in fact, may go through a major restructuring. You see that at some of the Pharmaceutical companies and this lab that you're talking to gets wiped out the next day. And so it's really the top executives that are making these capital deployment decisions is where you can get the volatility. So I think, from the actual user, we have very good visibility from the higher level. And that's why, myself and the rest of the team spend so much time with the customers, trying to understand what their capital budgets is, where they are, what they're nervous about, right? And I know Nick can talk and answer a lot -- the questions about the NIH spending. But those just put huge volatility into what's going to happen. Again, there's uncertainty, essentially causes delay of commitment. And so as a team, we try to do as best we can to try to sort out all of our intelligence to try to get a flavor of what's going on, because in capital deployment, those decisions are made actually quite rapidly. Very easy for companies to stop capital purchases or to moderate capital purchases and that's what we're always looking out. Not in the short-term as we know what's going on, it's what's happening up in the C suite.

Unknown Analyst

And then just one follow-up. As we think about the infrastructure you have to date, how easy is it to leverage that between the divisions? In other words, you've got great infrastructure around electronics in China, but as we think about the Life Science business building there, I mean, obviously, different customer set, but how easy is it to leverage the infrastructure you've got there today?

William P. Sullivan

As long as there's square footage, we can move anything, anywhere almost overnight. And again, our capability of putting IT systems and computer systems, bandwidth, space, as long as we have square footage, to be able to do that, we can do it. Secondly, the advantage of a centralized organization is they hear the needs of everybody, so when we space a building, we lease a building, we typically own all of our factories; we lease our sales organization or sales base. They size it so that we have flexibility. So for example, under Soon Chai, he called me up and said, "We have an opportunity to buy some space that Avago didn't need when we split off of Avago," right? And so we that, mothballed it and then when it was time to say okay, we need to be able to move products into this site, we could quickly outfit that space and essentially, we are able to move analytical instrumentation into Penang seamlessly, seamlessly, in terms of getting the IT systems up, the space up, all the infrastructure in place. It was done just as if they knew how to do it for decades.

Unknown Analyst

Actually one quick one for Didier. The dividend, should we think about that as increasing as a fixed percentage of net income over time? Or how do you think about your strategy around the dividend?

Didier Hirsch

Can you repeat the question?

Unknown Analyst

On the dividend, should we think about that [indiscernible]

Didier Hirsch

The best you should do is really consider it's going to stay constant, but really, you think about it, we are limited obviously, by our ability to generate cash in the U.S. We're not going to borrow to either fund the dividend or buyback. As our free cash flow goes up, and assuming the percentage doesn't change, we have more capacity for distributing the return in cash for shareholders.

William P. Sullivan

It's all locked to the tax policy in the United States. All bets are off. We can bring in $3.6 billion back to the United States tomorrow. I think that this team has a proven track record of returning cash back to the shareholders, and there's is no doubt in my mind that we would do that again. It's all caught up on this trapped cash situation.

Unknown Analyst

I had 2 questions. The first question is just looking at the shifting of production and manufacturing to Asia. So over the past 8 to 10 years, you've shifted a significant amount of your production and over the next couple of years, you are talking about more life science products and a little implementation products more into Penang. At what point do you think that, that stops? Do you think that from a risk management perspective, do you think that you could spend most of your production there, where are we in that, how far are we getting to something which you consider status quo and you'd like to maintain that equilibrium? The second question is looking at the competitive landscape across your 3 businesses from an M&A perspective. You've had tremendous consolidation within the space and across all 3 of your businesses in those end markets. And how does that influence the way Agilent behaves? Has that been an influencing factor over and above ROIC or these other metrics that you look at internally? And could give us some examples of that with?

William P. Sullivan

Yes. So first of all, yes, we have a powerhouse capability in Penang, 1 million square feet. But we do have very balanced manufacturing. Again, we have thousands of thousands of manufacturing employees inside the company, in Europe, the United States, Japan, China, as well as Southeast Asia. I know Soon Chai will talk about this. So we do not have a strategy of moving everything to 1 country. We would not do that whatsoever. And what's interesting is our factories in Germany are incredibly efficient. The factories that we inherited in the U.K. and Netherlands, I know that we can make a very, very efficient moving forward the factors we have in the United States. And given and if he, I think imprudent for us to put all our eggs in 1 basket, even though we've been in Malaysia for over 40 years and it's been a great bet, we will continue to be quite balanced in terms of where that is.

In terms of the second question, in terms of the consolidation of the market, we had actually, in our own discussions, in our own strategic planning, thought that this market would consolidate, particularly on the analytical side. We thought that it looked attractive for an industrial company to move in this space, given just the inherently higher margins and obviously, one of those had done that, moving forward. That also, in our thinking, by purchasing Varian, a Bay Area company, that we would've more critical mass to compete to what is now 2 bigger companies than ours, right? We are competing against 2 bigger companies than we are in terms of revenue and markets cap. I believe today, given the breadth of products we have, between Electronic Measurement, Chemical Analysis and Life Science, that we can compete against everyone. The good news is, there's not a lot of consolidation left, you know who are some of the smaller players left. And I believe the portfolio that we have that we can compete in, we're not at a disadvantage. And that's the biggest issue when you have a consolidating market. And I, quite honestly, I think that's what happened to Varian. You're stuck at $1 billion and it's a very, very hard to compete against multiple fronts against companies that are much more financed then you are. But I believe that we're in a very good position, and the proof of that, and you had asked for some examples is that organically, we, in fact, have consistently outgrown the market organically and I think that's a testament that we do have critical mass. We really do have a differentiator in our manufacturing capability, second-to-none in my humble opinion, and we have this R&D engine with our sales engine, that really allows us to be quite nimble to go after market opportunities and to play even up with any other company.

Unknown Analyst

So this is kind of a follow-up to the competition -- the competitive landscape question. So in the Life Science space in particular, there has been a lot of very rapid technology change, particularly, in the genetic analysis markets. I guess when you look at your portfolios, where do you see the potential for technology upgrades, technology advancements? Is there anything, when you look or in the Communication sides or Chemical Analysis that's potentially disruptive, revolutionary ones out there? And I guess a follow-up question of this, recent China announcements coming out of China, it's about them developing our own environmental analysis, environmental monitoring industry, how does that kind of fit into your plans and what do you see from the competition coming from the emerging markets?

William P. Sullivan

Yes, that's a good question. And a good follow-up questions for both Mike and Nick and there's plenty of others to give you a high level in terms of Life Science. And again, if you look at our strategy, we have not made big acquisition bets, that were for this process and this solution that may or may not get obsolete, right? I mean, what we have done is essentially built around a lot of our instrumentation on what we have. So I think the mass spectrometer market is going to continue, and again you're going to hear Nick talk about this, we have done exceedingly well entering in the Triple Quad time of light mass spectrometer market. What Nick has to do in his team is, understand the markets on these inflection points, SureSelect, the whole gene partitioning in front of sequencing. No, we don't have a sequencer. Lots of stuff going here and the latest announcement that was just made in terms of Oxford I think it's [indiscernible] instruments moving forward. But in terms of the SureSelect sample prep and what we do, it's very, very unique. How did we get there? Well, we bought a block D 11 automation company. We bought a reagent company strategy. So it wasn't like we took a reagent company and said we're just going to go compete at that time against Invitrogen, we're going to take this capability and redirect it in new solutions, new applications moving forward. The oFISH announcement that we made; our results, we believe, are substantially better than the existing guide. That is how we are going after this market moving forward. Again, Mike will talk about some of that Chinese competition. There are a lot of Chinese startup companies. It's been like that in the electronics side for many, many years. You're seeing it more in the analytical side, and they're getting better and better. People have to remember, though, it's not just about cost. It is the aftermarket sale. It is all the services and support the assets, the technology moving forward. But I believe that over the next decade, you're going to see Chinese competitors that are going to be a very, very credible. If China is truly going to be a science, engineering invention society, they've got to have the basic measurement tools to be able to make that happen, and right now, it's all dominated by Western hence mots to the Japanese companies. So it's all been dominated. So I think are going to see that and that's why our prices there, to look as local as we can, has been a big differentiator for us.

Alicia Rodriguez

I have a question for you. What time is lunch? Actually, it's time for us to break.

William P. Sullivan

Is it? Okay. All righty. So, thanks a lot for the questions. Go ahead.

I was is going to just mention lunch on the left. For most everybody if you ordered a kosher lunch, it's on the right-hand side. For the management team, we have lunch in the room that we were at before. Back here at 12 promptly and we'll get started with the business update.

William P. Sullivan

Thank you.

Alicia Rodriguez

All right. Thank you.

[Break]

Ronald S. Nersesian

You're going to get a chance to hear from each of the 3 Presidents to talk about their businesses, as well as talk from -- hear from Soon Chai Gooi, who is the Head of Order Fulfillment for the global supply chain for all of Agilent. At the end, we'll do a question-and-answer session of about 25 minutes to go have a chance and address any questions that you have. We're going to talk about everything within 3 different areas. The first, we're going to talk about how we focus on the right choices and how we make the right bets. So this will be all about where is the market opportunity and effectively, where we're going to place our investments. Second, we're going to talk about how we're going to exploit our technology leadership, as well as other advantages to create a competitive advantage so we can gain market share in revenues. And third, we're going to be talking about operational excellence and all the new things that we're doing in order fulfillment in order to deliver bottom-line results as well as top line results.

Okay, great. First, as we talk about focusing our portfolio on the right bets, as Bill has described earlier, we've done a very good job of making sure that when there are new opportunities, we've reallocated our portfolio as we see certain markets such as Life Sciences that are growing faster than other markets, we've managed to make shifts, not only within the businesses, but we've also done that in our global infrastructure and how we have actually supported our businesses. So we're going to discuss the top megatrends that are driving our business and from there, after that, we'll talk about how we will win and how we will differentiate in every area.

The second thing we're going to be talking about is winning in emerging markets. So not only is it important to go ahead and to focus on the right megatrends that exist, but we also want to make sure that we capitalize in the new emerging markets. The third point that Bill mentioned is we are building up a larger and larger annuity stream with our service, support, chemistry and consumable businesses. And that has reached $1.7 billion right now and very solid profitability, probably around Agilent average and that continues to bring a larger and larger base of bottom-line EPS to our business.

The second area is all about technology investments and how we use our organic growth engine to differentiate ourself with the technology. Of course, we will make acquisitions to complement that technology, and we will utilize many other things throughout our whole value delivery system to make sure that we have market reach and we have customer trust. But we really are an organic growth company at heart. We're very strong in that area. Our organic growth rate is higher than the competition as you've seen most recently and we are going to get a chance to talk about that and a differentiation that will drive at Agilent overall growth and market share gains. Third, after we've generated this revenue, we're going to talk about how we turned that into cash at the end of the day. We've made great operational improvements over the last years, and we are continuing to strive to take that to the next level. And the consolidation of our overall supply chain to really create $1.7 billion operation that is a world-class supply chain, logistics organization and instrument manufacturing will help us achieve the goals, the gross margin goals that we have set out.

As we look at our markets and end markets that we play in, these are the same markets that you've seen before, and we're very focused on these markets that continue to drive the opportunity that exists and we continue to reallocate our portfolio of investments to make sure that we capitalize on these new opportunities. On top of that as I've mentioned previously, we're seeing our annuity business grow, and as we see over the next 3 years, we have, we see approximately 17% growth in the developed world, as well as -- excuse me, in the emerging world, as well as 4% in the developed world, which brings us to the overall market that we have. But on top of all of that, in all of the regions, in all of the markets, the annuity business is a very, very important point. So how do we win in emerging markets? We have grown substantially over the last 10 years since our split from HP, and we see substantial growth in the future. So I just mentioned 17% growth in the emerging markets and 4% growth in the developed world adds up to our plan as our plan, getting us to approximately $8.5 billion in 3 years. In order to make this happen, we have invested early in China, and that's why our China business is over $1.2 billion right now, and we are doing that and accelerating it even more. So we're making 2 changes. One, we're making sure that the country managers have one President to represent Agilent to get real-time feedback on what's going on in each region to make much quicker decisions so we can move at the pace of these markets. On top of that, as we look at the executive staff, we'll be able to bring the voice of all of the emerging countries right to the staff for immediate decision-making. So each one of the Presidents have special roles of looking after emerging markets for each of the markets that exist. On top of that, Nick Roelofs will be moving to Singapore to be in Southeast Asia. And with our new staff structure, where we have 3 Presidents and we have our Global Head of the supply chain and order fulfillment, we will have 50% of our staff in emerging markets, on the ground within a couple-hour plane flight, whether it be to China, to India, to the rest of Southeast Asia. And this really will change the dynamic and the emphasis and the focus to make sure that we achieve that 17% growth in these emerging markets. The next thing is not only focusing on the right markets, and you'll hear a lot more from each one of the Presidents with regard to each of the market opportunities, but also on what we are doing to win. So in technology leadership, we have been investing organically. As you know, our R&D investment is about 10% of R&D and as Bill had reaffirmed that we see that investment continuing as we go forward. And not only do we have 10% investment in R&D and 2,600 R&D engineers, we have a 3 tier strategy to this technology development. And it goes from short-term to long-term and it also is organic and inorganic. So on the organic side, it's very simple. We have the divisions working on R&D. These are the 35 entities that Didier talked about. On top of that, we have technology development centers that are located in California, Colorado and Beijing that will go ahead and look where there is commonality. So a different product line just doesn't work on technology for their product line, but if there is product, if there is technology opportunity that span multiple product lines, we work on that in our technology development centers, as well as the third part of our strategy, which is Agilent labs. And they have bought to market technology that has fueled our organic growth, and we continue to see this as a key part of our strategy. Two examples of the growth that we've just, that we are achieving right now are through 2 new introductions that we've just made. Last year, we introduced the world's most sensitive Triple Quad with Ion iFunnel technology. This Ion iFunnel technology was invented in Agilent labs. And most recently, what we have done is we have added some of our RF expertise from electronic measurements to create high-speed RF pulsers and A to Z [ph] converters together to create the world's most sensitive bench top, Q-TOF and the technology itself is not that important, but what's really important is what we're doing is utilizing the lab's technology, the division's technology to bring world-leading products to the market that is fueling our growth.

Another example that exists is in the Chemical Analysis Group. We have introduced a brand-new, revolutionary microwave plasma atomic emission spectrometer. And what this does is that it uses microwave technology from our company that can go ahead and replace the need to use gases that are very expensive and that are also flammable. This machine runs on air. And customers look, when they look at their total cost of ownership, they can't get this product from anywhere else. The other thing that I think that's really important about this is this is a good example of our acquisition of Varian to buy some of the core technology or the core ideas to invest in that in organic growth and with the technology that exists in Agilent and bring to market something that does not exist. Guy will also get a chance to talk a little bit later about some of the examples that we have in oscilloscopes, down deploying our high-end technology into the mainstream, our most successful product launch ever and also into handheld product. And not only in the oscilloscopes, but also in RF and microwave products. The next thing I wanted just to mention is it's great to have growth and have ways to get the growth and differentiation, but if you can't bring that to bottom line results, it's all wasted. So as you know over the last 2 years, Soon Chai Gooi has been leading up the order fulfillment organization in EMG, which has delivered 4.9% gross margin or 4.9 points of gross margin improvement. He has also helped the organization deliver very high incrementals, $749 million in profit increase over the last 2 years on $1.1 billion of revenue, or approximately 67% incrementals for EMG.

And that has been helped -- has been made possible, a good portion of that, by the work that has been done in order fulfillment. As Bill mentioned, we have $1 million -- 1 million square-foot facility in demand, and that they're not only working on products for one group, but they've also been working on products for all 3 groups. An example of that is looking at the console or the RF console for our NMR magnets or NMR systems. Those are produced, for instance, in Penang. The UV-Vis products, which are out of the Chemical Analysis Group, are also produced in Penang. And those are just some of the examples of how we've leveraged the technology and the capabilities that we have in Penang into the other business groups. And my new role of looking to: one, help grow the top line with the focus on the emerging markets; two, make sure that we go ahead and we deliver the operational improvement that Bill talked about, the overall 5 points of operational improvements to Life Sciences and the Chemical Analysis Group. You will get a chance to hear more about that in a little bit.

So in general, you're going to hear from the next 4 speakers to talk all about specifically what that they're making in the key growth markets that are capitalized on our 5 key megatrends, be they mobility, improving human health or food, environmental and energy demand needs and opportunities. Then on top of that, Soon Chai will wrap it up and talk about what we're doing in operational excellence. Followed by that, we will get a chance to do a question-and-answer. So with that, I'd like to take the opportunity right now to go ahead and introduce Guy Sene.

Guy has taken over as the President of Electronic Measurement Group. Guy is a very seasoned manager that has been working with the Electronic Measurement Group for over 30 years. He has run multiple divisions, 3 different divisions, including most recently, the largest division in the country. He has produced -- excuse me, in the company. He has produced exceptional results there. He has also spent time working in the field organization and has worked on all 3 continents in -- or 3 major continents: In the U.S., in Europe, as well as in Asia, starting up and pioneering marketing centers in Europe and in Asia. But his seasoning and understanding of divisions, the customer, as well as the field organizations makes him an ideal choice to lead us into this next phase.

So with that, I'd like to turn it over to Guy.

Guy Sene

Thank you, Ron. Does this work? So good afternoon, everyone. As Ron was saying, my name is Guy Sene, I'm the President of the Electronic Measurement Group and it's a real pleasure to speak about EMG. I'm going to go towards different market segments we address and focus a little bit on why we win and how we're going to win in this market segment. But before I go there, I just wanted to remind everybody that clearly, EMG is the market leader. We are the #1 in all core product categories that we address; oscilloscopes, we are #2. We have the broader set of solutions in the industry, and we have extremely strong customer loyalty. We measure the customer loyalty every year. It's called blind survey, it's a tentative survey. And year after year, we come up with the highest customer loyalty. We're also very well positioned in emerging economies. As you heard from Ron, a lot of more investment there, but already, EMG has 51% of the global workforce in Asia and has been a focus for a long time. Our product strategy is clearly based on -- let me just -- sorry, our product strategy is based on technology leadership, and then we use this technology leadership and deploy it to more competitive products and solutions to address the broader market, obviously. And last but not least, we have a very strong operating model. As you know, we come from 2 years of very solid growth of over 21%, 23% year-over-year. And while Q1 was a little soft, we still see the 21% operating profit and 58% of incremental.

So our markets, clearly, the Electronic Measurement market is, of course, $13 billion plus, growing 3% to 5%. We address this market through 3 major market segments: one is communication, the other one is aerospace and defense; and the third is real [indiscernible] segments of industrial, computer and semiconductor. The important piece here is that all of these major segments that EMG addresses has growth of opportunity and major growth drivers and are going to go [indiscernible] but after [ph] that highlight, you've heard from Ron and Bill, mobility to connected world is really the order what's rising the communication industry. In aerospace and defense, it's all about technology advancements and state-of-the-art upgrades rather than large forces. And in our industrial, it's a set of growth drivers. I'm just going to mention electronics everywhere, electronics in any product are in fact in our multiple industries that give us a lot of opportunities there. The one thing I would like to highlight on this slide is that while the segments, obviously, where we focus in emerging economies goes faster because they play a major role for all of this major segment.

So with this, let me start with communication. Obviously, communication and -- is a very important market for us. It has been a major growth opportunity. We grew 30% last year in this market segment. And it will continue to be a major growth opportunity for us in the future. Yes, our results have been a bit weaker a bit weaker in Q1, and you notice that this market has very solid market drivers and clear fundamentals and foundations for future long-term potential. And that's why I expect this market to be growing at 6% to 8% over the next few years. Clearly, what lies there? There's a lot of elements that you probably know very well. But I would just highlight the fact that the smartphones are just pouring in extremely fast. We produced or I think we produced close to $0.5 billion of smartphones this past year. That's huge. And it's still growing 30%. It's expected to grow 30% this year, probably reaching 1 billion phones in 2014 to '15. That means half of the phones at that time will be smartphones. So a very important driver. The other driver is all the subscribers. The subscriber growth is going very fast, keeps going fast, and we're going to reach 6 billion subscribers at the end of this year, 6 billion. And by the way, 1/3 of these subscribers will be in India and China. So major growth there. And all this is putting, in fact, a lot of advantages [ph] on the data-hungry networks. And as you may know, the amount of data that is carried through wireless networks is doubling every year, has been doubling every year for now 5 years and is projected to continue to do so in the future. So this puts an immense, tremendous pressure on the whole industry. The communication industry has to cope with this fast growth cycle. And you all heard about LTE and 4G standards are -- that's really a way to try to get the most efficiently data communications through the airway. LTE is only the beginning. We're at the beginning of this long cycle that's going to take 10 years for this standard. And by the way, while we're speaking in the beginning of LTE, I’m just coming back from Barcelona, where we had the Mobile World Congress, the major industry event for the communication business, guess what? People are speaking about LTE-Advanced, a new generation because [indiscernible] just give more techniques available to even broaden or expand the efficiency of the networks. So that's one element. Other people in the industry try to stretch more what they have. So 3G is here for the long run. More companies try to stretch the ability of 3G, your HSPA+ in other ways give base much better return for some of the operators and we be keep seeing investment going in this part of the standards. On the base station, same thing. A lot of investment going into multi-standard base stations because it's not like I just add LTE base station in my marketplace. If I have to deal with all, I need to deal with 2G, 3G and 4G signals at the same time and those are types of investments in R&D that's happening and you'll see future. And I'm not speaking about the whole dialogue. Do I need big sales, small sales combination of all these cell stations?

Also trend is the wireless LAN plan. Obviously, everybody wants to upload the network and wireless LAN with new generation of wireless LAN. Is it 802.11 AC or AD are investments that are happening as we speak. And last but not least, how do we get more out of the optical network that is the backbone of all the communication system that we have? How do we get more of this backbone? So there is a lot of possibilities. What I can really tell is that in the next few years, this industry will keep innovating at extremely high rate, and Agilent is uniquely positioned to really take, as we have taken in the past and will in the future, advantage of these technologies. So we address this need in the Communications system differently from others. We really differentiate by a number of ways. The first is we address the whole ecosystem. That means we have solutions for the handset, the industry, the people that create the handsets. We have solutions for the infrastructure industry and we have solutions for the component suppliers. And clearly, this allows us to really leverage the cost of all industry when we speak about the key technology like LTE.

The other way of differentiating is once we go into a specific sub-segment on this slide, you have the handset life cycle. So is this our way that any designer of a new handset that you prefer has to go; sort of different stages before it can go and be in your hand and really you can use it. So it starts with design validation. It then goes to chipset development, hardware integration, design validation, conformance testing, and ultimately, they want to produce it. We have a full range of solutions that allow our customers to really have the right tool at the right time. That's, again, a breadth that is unheard in the industry. You see for instance at the upper left side here, our leading software environment that is being used by most of the communication and aerospace and defense customers as a key element to stimulate the products. Bill was commenting earlier, we just acquired a company called Asilicon [ph] that is helping and giving us additional feature in this overall software simulation space. I'm not going to go sort of all product description, obviously, but I wanted that to highlight the end here, this is our newest manufacturing test platform. It's called the EXT. It allows to test in production hand forms from 2G, 3G to -- and 4G. And it's currently in production in major smartphone manufacturers across the world. So very successful there.

Obviously, products are very important. And I mentioned a few of them. We keep on innovating in our portfolio. And just last week, in Mobile World Congress, I have introduced more than 12 new products to this industry. On this slide, you'll just see a couple of them. The one that is here is a new optical modulation analyzer. And this really combines the strengths we have in our high-performance oscilloscopes with the expertise we have in RF to create a state-of-the-art optical demodulation capabilities with a very high accuracy. So that's one example of very strong leverage. The other one that I just wanted to just share is a new multichannel product that is first, again, in the industry. It's based on our modular platform. It is an 8-channel modulation analyzer that allows, for the first time, people to test the designs in LTE, LTE-Advanced, where MIMO is a very major component and this product can go up to 8 channels. But products are not all of the [indiscernible] successful in this marketplace, and the contact, the closeness with customers, is critical. We have R&D centers across the world. Here on this slide, I mentioned the China communication operation. By the way, I lived in Asia for over 5 years, as Ron was mentioning. I understand the importance of being close to these customers. And as you know, China has specific standards. So TD-SCDMA, LTE-TD, is an evolution of specific standards there. Our ability of having over 200 R&D engineers based in Beijing, close to these customers, helping them with the local needs as well as global needs is clearly providing major contribution and a major differentiation in this industry. Other thing I would like just to highlight here is the leadership in technology standards comes because of us, our specialists being part of all the standards. Any standard gets created, brings a lot of people together, we make sure that some of our specialists are part of these standards' committees. This allows for first to make sure that whatever comes out of the standards is testable. And second, it gives us the lead. And very often, we're able to bring out to market, technologies of measurement solutions even before the standard is announced. We did this in LTE, we did this in LTE-Advanced, we did it in 802.11 AC, for instance. So very strong story, and again, it's a combination of strong portfolio and local presence that helps us win in the communication market.

Let me now switch to the aerospace and defense market. This is a very -- a different environment. It's a $3 billion market. Important, we think it's going to be flat for the next 3 years. But in the same time, we are very well positioned to capitalize on some of these strategic investments that are going to be happening there. You all heard that the shift that's going to go from smaller forces, more agile, very high technology, state-of-the-art technology type of equipment that's happening in the U.S., it's happening in Europe. You'll also see more investments in this industry happening in China, but also Russia and other emerging countries as they start building a more state-of-the-art aerospace and defense industry. And also in this industry, a number of very critical programs that will come out. The new radar technology, for instance, is an environment where there is more and more investments happening. And just to name another one on the slide, that's a whole investment in satellite. It's a navigation type of solutions or military satellite is going on.

So we win in that marketplace clearly because we have an extremely large and very loyal installed base. This market is all based on high technology, high performance, and that's core to our product strategy. So it's an extremely strong fit for us here. But it's also about high reliability, very strong quality and the ability of supporting the customers in this industry for very, very, very long time. It's 15, 20 years and more than that. So we have [indiscernible] than this and we have a very strong position there. On this list, you'll see a number of solutions that we have just introduced recently. Obviously our core product categories; is it network analyzers, signal analyzers, signal sources, oscilloscopes, all playing a major role in this industry are sort of the high-performance element. I just wanted to highlight one that is a little bit different, Ron alluded to it in his introduction is another way of deploying our high performance, high technology that we have into different form factors. And here, it's a handheld solution that we have. This is RF handheld, RF and microwaves signal and spectrum analyzers. We have a whole range of products now and making inroads in the market. And obviously, we will keep adding more, investing more in the very near future in this type of product category. It opens the installation and maintenance market and the portable market, especially in aerospace and defense.

The industrial, computer and semiconductor is our largest market segment. It's also the most diverse that we have. There are a lot of those drivers. The ones that I would just like to highlight here is 3 different ones: one is mobile computing, cloud computing, really create a massive amount of data that needs to be transferred or stored somewhere that relies on the ability on the feed on specific serial buses. So a lot of investment and discussion in technology are on this high-speed process. Is it on the mainframe level or at the USB level that we'll see and we'll keep seeing? The second trend are driven by the overall semiconductor ability. It's obviously the fact that we have electronics everywhere from automotive to health care to energy management. And this opens up for having a number of more customers in a very diverse set of place. And finally, the overall investment that go more and more into education and research as this segment is more and more strategic for many of the emerging countries that we address. So in this market segment, we win clearly because of 2 major things: the first is we have an extremely wide catalog of solutions. Basic instrumentation that people can use and has just the needed performance for what they it look for. The second element, I think Bill mentioned it, is we, in the past 2 years, we invested heavily in building alternative channel, especially distribution channel. That is now very effective across the globe. So the combination of these 2 gives us really additional reach in this market segment that is making progress. Just as an example, on this upper-level slide here, you have our oscilloscope that got introduced a year ago and this entry-level oscilloscope, obviously, very strong characteristics and a very strong product. But the combination of this portfolio with our indirect channel has allowed us to double for the installed base the number of customers we have into oscilloscope business. So I could go and probably hit a few others here on this slide, but for the time we have, let me really conclude here. And to remind you and I hope I gave you a few elements here that the Electronic Measurement Group is clearly the premier measurement company for electronics. We are the market leader. We keep innovating in all this space. We are very well positioned to capture the growth opportunity, especially in communication and especially in emerging countries. And Soon Chai will later speak about the operational excellence that we have, and obviously, on the OS side. But clearly, this allows us to command this high-operating margin that fits the Agilent operating model. Thank you for your attention, and I think it's to Nick now.

Nicolas H. Roelofs

Thanks. So is that microphone working? Can you hear me in the back? Great. Thank you, Guy. Thank you all for giving me an opportunity this afternoon talk about to you about the Life Science market and Agilent Life Science opportunity. We're really excited about this market. We continue to think that this is one of the best markets out there. So I'm going to walk through some overview of the market, try to dive down a little bit into the products and hopefully touch on a few points that then can set up for the Q&A later if you have any other questions. So let me take a macro view of this market for you. This market is Agilent's largest market opportunity. The way we calculate the market, we see this as a $21 billion TAM. That makes it about 47% of Agilent's TAM. Yet Life Science group is about 22% of Agilent. So not only is it the single largest market opportunity for Agilent, but it's also a place where we're fairly underpenetrated. And I'll talk a little bit about that penetration opportunity underlying the secular and macro trends that are in this market.

In terms of the overall market, we see a 4% to 6% growth. Frankly, this market is a GDP-plus market. And we've seen this market be pretty much GDP-plus 3 for a couple of decades. And if you go back and map it, that's kind of the number you see as the growth, which is at the high end of this range right now. And so that's something we think is a fundamental, secular trend. And why do we think it's a fundamental, secular trend? So far, what's tying and driving this market is 2 fundamental things: first, the overall healthcare aspirations of people around the world. There does not seem to be a cap of the percent of GDP the people are willing to spend on healthcare. The United States, in about 7.2%, is the highest spend. And what do we talk about effective healthcare is a different discussion that doesn't seem to be a cap on willingness on how much countries will spend. China's coming up. It's moving north of 2%. So there's some real movement opportunity in here to see a lot of GDP diverted to healthcare. Obviously, Life Science rides sort of behind the tail of healthcare or in front of the wave of healthcare, depending on your perspective. And that's because the primary submarkets are Pharmaceutical and the primary submarkets are academic. And the other secular trend that we see underneath all of this is a fundamental belief that science and technology, particularly Life Science, is a whole market of developed countries, developing countries and the future. And we just see that as a strong underneath driver. So that's why you see the points on here. What you see is a comment about BRICs. Why is there a BRIC comment? Because emerging economies in general and BRIC economies in specific are investing heavily in Life Science to play on the world stage, to be fundamentally solid in these spaces. That's the same type of secular driver as the comment in growth in generics. We're seeing Pharmaceutical therapeutics in general, relocate to countries that want more Pharmaceutical and therapeutics in their home economy. So this is no longer a, "I will put my plant in India in order to make cheap therapeutics that I can export to some other part of the world." This is, "I will put my plant in Belarus or I will put my plant in Russia in order to feed my local economy in therapeutics." So these are strong, secular participatory trends.

Let's take a dive into the subsets here. So Pharma. We see here an 11 -- sorry, an $11 billion segment. Again, solid 4% to 6% growth as a reminder in our Q1. This was in the mid-teens for us. So solid Pharma growth. This has been a really good sector in general and great for Agilent. Under here, what we see is we see what I'll call a cyclic trend but with long cycle. And there's 2 big cyclic trends, one big secular. The secular I mentioned already, which is the relocation geographically, which also is driving local therapeutic markets or driven by local therapeutic markets. The cyclic trends are really 2 technology waves going on. One is a very long cycle wave. This is a conversion from New Chemical Entity drugs to New Biologic Entity drugs. This has been going on for about 10 years. It's at about the midpoint, approximately a little more than half the drugs in Pharmaceutical types and our new biologic. I couldn't say that 2 years ago. The recession of '09 actually accelerated that because it gave the Pharma guys air cover to transition their R&D teams from chemical teams to biologic teams. And this is now accelerating. So that's a great cyclic trend with a long cycle. And then second, there's sub-technology upgrades in the case of UHPLC. There's a sub-technology upgrade trend there that's cyclic with the cycle period of probably 4 years or so, maybe 3.

What is Agilent going to win in Pharma? How are we winning? Well, I just told you that the secular macro trend is that geographic relocation, that need to put therapeutics into your own market. And we are well positioned in China, India, Korea, Brazil, Russia. We're really in front of this trend as a company. We're there to serve those customers. And since we have a very stable and decent Pharma footprint in the G-8 countries. As our customers relocate, we catch them, whether they're building their own plant in India or whether the drug becomes generic off-patent and gets picked up by a generic manufacturer in Korea. So we're well positioned for that trend. We're also in great position in terms of the technology. And that really is the fundamental. So here there's a core of Agilent. We have market reach and customer trust. We're out there and we have the technology investment. Bill talked about the R&D. And so we've got great, new products and technologies in this under-covered area and we're moving along very solidly, with Triple Quad and Q-TOF, with great innovation. And we're adding in pieces and integrating systems across the workflow of the Pharma customer as they evolve to New Biologic Entity.

Academic government. This the market that we are very underpenetrated in. We see this as about $10 billion or a little under half of Life Science market. Pretty solid growth. Our view on the growth has slowed a little bit because of the headwinds of what's going on in G-8 countries with budgets. But there still has not been that to political will in any country we have seen to cut the funding to academic government science and technology. So we can argue about the NIH sequestering problem that may or may not occur in the '13 but to-date, there hasn’t been a political will. We see it as a solid trend. We also see a huge push in emerging countries. We see these countries wanting to play on the stage, as I mentioned and that China is a great example. So most of you heard in Wen Jiabao talk about at the People's Congress earlier this week that China was going to reduce its growth rate from 8.5% to 7.5%. What I heard was an increase in the research funding of 12.2%. What I heard was a specific program to increase the spending in universities by 24%. That's what I heard in Wen Jiabao's speech, and that's what we see going on in this submarket. Also, people worry about the NIH. The United States, while it is 31% of the spend in this market as a government-backed spend, is still seeing a lot of the power, but look at the top 8 Asian countries. 35% of the total spend. Five years ago, they were less than 10%. It is a huge movement.

How do we win? Again, customer trust and market reach. A theme you'll hear from all of us, we are there, we are there early, we are investing in these emerging markets. That is how we win. Second, you’ve heard from LSG, from the Life Science Group, that we are investing in a separate economic channel. We put a lot of money in; we're in our second year. We're coming into the third year of this investment in the Life Science channel. We're putting experts in the field, we're out there talking to leaders; we're monitoring the market. We're putting money behind getting into this market because we are so under penetrated. By the way, it is a 3-year cycle for grants. So we are going to start to see some real inflection in our SG&A investment. So Life Science Group is no mystery. We are the lowest operating profit of this company. Why is that? We've got a lot of investment going on in R&D. We've got a lot of investment going on in SG&A. That SG&A leverage will start paying off next year, as we enter that third year and start catching the wave of the grant cycles because a significant portion of the SG&A subset has been in this channel split. Technology. We're all about adding technology pieces. Bill talked about it at the very beginning. We want to assemble all the pieces to solve the workflow problem for customers. That's what we've done in our acquisitive strategies. We've looked at small bolt-ons. We've looked at technology pieces, we put significant amount of R&D in organically inventing technologies. We talked about, and you've heard about Ion Funnel in our Mass Spec. We are out here to win technically and we're out here to leverage those investments with market share gains, and we've been growing at approximately double the market rates and think we've got momentum to continue that growth across the portfolio, and particularly, mining this academic government subsector.

Finally, a piece that we haven't talked about much, our molecular diagnostic path. So those of you that have listened, we've said the word diagnostic quietly, it's been in slides. This is an area where we are very cautious and very, very methodical in how we are entering. We do not want to create a tremendous amount of hype, but let me give me a picture of where we've been and where we're going. We see the molecular diagnostics market as a $4.5 billion market growing at 10% to 15%. What do we need to do to get there, is a question we ask ourselves. Well, first, we need fundamentally stable technology platforms because if we're going to introduce markets, we've got to have technology. We're certainly not going to enter in because we know all the doubts that we have fundamental experience here. What has the Life Science group done? We've reached, as you heard, $1.5 -- $1.8 billion. We are now a co-leader in LC, from technology investment. We are #1 in Triple Quad volume out there in the marketplace, from technology investment. We have unique capabilities in our oligo synthesis and our microarrays that have put us in a real technology position with customers' acceptance. We've acquired the capacities necessary to create diagnostic kits, reagents, complete the solution. These, of course, have been winning in the Life Science market place, with the reagents, with automation, with informatics. So that we could complete that solution for the customers, which, by the way, is the Holy Grail in diagnostics. We're out there with manufacturing capabilities. Soon Chai will certainly talk about our overall strength, but we have converted our facilities to meet FDA regulations. We have registered LC and LC/MS as Class 1 devices with the U.S. FDA. We have done all of the fundamentals necessary to enter this market. Now what is needed in the market? What is needed in the market is the ability to go in and solve the workflow problem of the customer. The drivers are pretty simple; increased healthcare demands from aging, a huge driver; emerging market demand. Believe it or not, molecular diagnostics has a real opportunity in emerging markets because they don't have the embedded infrastructure of historical diagnostics to fight against. In the pathology lab, we are introducing, and introduced on Monday of this week, a product called oligo-FISH or fluorescent in situ hybridization based on the oligos that come off our microarray. This is a breakthrough technology. This goes primarily to pathologists that look through a microscope and a piece of tissue and these people look through that tissue for a light. The current technology uses bacterial chromosomes. It's mucky and when you look through this microscope, what it looks like is a watercolor painting, diffused colored blobs. What we've done with oligos is we've created a technology that allows you to look at the same slide through the same microscope and the lighted spot looks like the fine line of a pencil. It's bright, it's clear, it's a thousand times more sensitive than the back technology. And our fundamental manufacturing costs are unbelievably small because it comes right off leveraging our microarrays. So we launched that on Monday. This is a $300 million market that we have the opportunity to enter. So this is the kind of thing that we believe we've got fundamentals in. So in the past, we've talked a little bit to tell you that we make real-time PCR instruments for Siemens, we've talked a little bit to tell you that that we are the producer of the Agendia MammaPrint microarray and the CupPrint microarray, and so we are producing diagnostic products today that others have registered. We've just told you that we are in the process of completing registration and technical capabilities in our factory. And we are now ready to kind of come out from under the covers and say, it turns out that in that Life Science number, in that 22% of Agilent, there is some diagnostic business. And it represents today about 1% of Agilent, it's very small. But we have a process to methodically go forward, look at registration, take these opportunities and proceed into the marketplace leveraging the capabilities we've built methodically and ploddingly over the past 5 to 6 years.

So with that, what is it that the Life Science group does to win? Well first, market reach and customer trust. We've talked about the academic investment, and I've made the comment that this is going to leverage into our P&L and operating profit in the next few years. And you're going to see us continue to move that operating profit up. We've got technology. We're going to continue to invest R&D in order to make our products leading edge. Someone asked earlier today, how do we put ratio of R&D? In Life Science, we've been the investment group for Agilent. But frankly, it's all about critical dollars. We've got to have the number of R&D dollars equivalent to or greater than the competitors to win. Simple mathematics. And that's what we've been able to do. Because of the Corporation's operating model, we, Agilent's LSG group, has been at the sort of 30% incremental end of that range. That's been very open to you. And that investment has gone into R&D. And that has allowed us to leverage and go into and win. It's a dollar-based perspective. Also, because we're growing at such a high rate, we only need to out-dollar the competition which means we're going to start to get P&L leverage on our R&D number. So what you'll see from us is you will see us use customer reach, you will see us use technology on top of the tremendous scale that Agilent has. The Life Science group has moved a lot of products into Penang, a lot of products into Singapore. Our Mass Spec, our Automation is in Singapore. You've heard about the RF consoles out of NMR being in Penang. We're leveraging that supply chain. I've been partnering with Soon Chai for 3 years. He now has the full responsibility to take this to the next level. And the combination of these 3 elements give us a path to visibly see a 20% operating profit in this business in a 3- to 5-year horizon. It is a very methodical, clear focus of where the team is going. And all of that is built on a world-class team of Life Science expertise, of real talent and of real education that we have instilled into the Life Science organization.

So with that, I'm going to turn this over to Mike who's going to talk about his chemical markets, as well as the infrastructure and the background for service and support that he also manages for Agilent.

Michael R. McMullen

Thank you, well done. Thanks, Nick. And it's real pleasure to be able stand in front of you today to talk to you about Agilent's Chemical Analysis business. Where our market's going, and I'm going to share with you why I believe we're uniquely positioned to capture the opportunities I'm going to show you.

Agilent's Chemical Analysis business, just like much of Agilent, is in the business of helping our customers improve the quality of life. We help our customers to answer questions like, is that food that you had for lunch today safe to eat? How about the water? How about the toy that your child is playing with? Or, where is that gasoline going to come from to fuel my car in the future? We're working with our customers to help answer those questions. Literally, our customers are affecting the lives of billions of people across the world. You heard Ron, you heard Bill and Nick, others referenced these global megatrends. These are driving the Chemical Analysis business markets. We are in sustaining growth markets. And if you had a chance to look at our numbers over the last several years, you know that Agilent has been outgrowing the competition for the last several years. Why is that? I look to our unique market insights, our breakthrough technology and really, a rare combination of local presence and global scale. That translated into a superior customer experience and superior growth. Now what I'd like to do is take a deeper dive into the 3 major segments that make up the Chemical Analysis market. What's going there? What are these trends that I'm talking about? And why is Agilent positioned to do extremely well in this space?

My guess is that none of you coming to this event this year paid less to get here. We know that energy prices are going up, $4 a gallon of gas in the U.S., projections of $5 by this summer. Increasing demand, driven by the relative economies, new needs for raw materials, chemicals. Our customers are looking for new sources of fuel, shale gas, tar sands in Canada. Bill mentioned earlier, "Hey, Mike was just down in Brazil." I was in Brazil last week, visiting ICP, a big research Institute in Brazil, Sao Paulo. What are they doing? They're looking for second-generation biofuels. Why is that? We may know that Brazil's the largest producer of ethanol but mainly from sugar, sugarcane. Well, guess what happened last year? Sugar prices went up, that crop gets diverted to the food market. They had to import ethanol from the U.S. into Brazil to produce the fuel. What does that tell you? These first-generation biofuels won't cut it for the long-term needs of the market. Great research plays right into our strength in terms of providing leading edge technology to researchers. And when downstream testing arrives, we'll be there to capture the opportunity.

So how will Agilent win in this Chemical and Energy space? Well, we've been winning there over the last several years, decades, in fact, I would argue. We have a long heritage of being the leader in this space. We have customer trust and we have, really, a very strong position in the marketplace already. But we're not making that for granted. We're investing very heavily. And I want to call out a few opportunities here or recent examples. The, what we call the ultimate answering machine, our GC Q-TOF. This is a brand-new instrument that we just brought to market. It's unique. Nobody in the world has anything like this. Well, what's it used for, Mike? Let's go back to this story about the energy markets and the petroleum companies. So as you may nail up, a lot of the crude that's coming out of the market these days is heavier crude, has lots of contaminants in it. So -- and that's not good for your refining processes; it gets things all up ganged up and up cost companies lots of millions of dollars. Just to give you a sense of the trust that customers have in Agilent and the belief in our technology; we have this product under development. We showed one of our energy customers in Europe some of our data. It was all done by WebEx. And next thing you know, the customer places a $400,000 purchase order with us. Bought the product from us, straight on the scene, never touched the instrument. I'd like to say it's like buying a Ferrari without ever having and taken it for a test drive. I think it really shows you the customer trust that exists in this space for Agilent. We just introduced the world's smallest FT-IR, the Cary 630, part of the key strategy we have about building our capability through acquisition and bringing those core technologies into our core markets. And then I mentioned earlier, this local presence tied to global scale. There's an example here. We worked with the China National Petroleum Corporation for petroleum analyzers. We have on-ground teams in Shanghai. We have developed an investment expertise, and we can provide tailored solutions to the local markets. And an example here, we sold 68 GC analyzers of petroleum space last year. By the way, that portfolio was enhanced by the acquisition of Varian. So again, I think there's a few examples of leading-edge breakthrough technologies, how we work in the local market and really enjoy this customer trust that we leverage for commercial benefit for Agilent as well as our customers.

Let's take a look at the environmental on forensics market. So human health, considerations aside, which I think we're all quite aware of that already, there is a growing recognition in the world about the interplay between economic growth and the quality of your environment. If you picked up the China 12th 5-year plan that talks a lot about economic growth but also talks about the importance of the environment. And they have come to realize that if you're going to be global exporter of food, you've got to have clean water. You've got to have uncontaminated soil. All these situations present opportunities for Agilent in terms of opportunities for growth number, really playing off our local presence in these markets. In the Forensics market, lots of concerns in the Pharmaceutical space, new designer drugs that abusers [ph] getting their hands on, performance-enhancing drugs in sports. Or in the Pharmaceutical area, we've seen a real flood of counterfeit drugs in the market. You may know that all the major Pharmaceutical companies have major counterfeiting departments. They have agents versing the world looking for counterfeit drugs to raise awareness of the existence of these drugs. The counterfeiters are getting very sophisticated. Looks like the real thing, actually have some active ingredients as well but doesn't do what is it intended to do. Huge human health consequences on -- particularly in the Third World and obviously, the economic side for Big Pharma. Again, all these situations, all these trends provide opportunities for Agilent as we forward in this space.

How do we win in this space? Similar story here. Well, you've heard already my It Runs on Air story. I think this is a great example of we're not bringing new products to the market. We're bringing revolutionary, breakthrough products to the market that nobody had that really speaks to the power of our capabilities and all instrumentation, displacing higher-end, much more expensive, much more complicated systems to use. And then finally, we're out in front, working with the leading researchers in this space. Shown here is Dr. Shane Snyder from the University of Arizona. For those who may not be familiar with Dr. Snyder's work, he was revolutionary, the pioneer in really identifying the impact of trace steroids and the contaminants in the reproductive process for fish in the Colorado River basin in Lake Mead. His research now is focused on looking at the human health consequences of trace Pharmaceuticals, personal care products in the water supply. Why should you care? Lake Mead in that area, provides water for 10% of the U.S. population, 30 million people. This is a big deal. And his type of research would not be possible without the technologies that are coming from Agilent to help him do his work and really address what are some really serious questions that are being put forth today in the environment.

This market, let's talk about food, one of my favorite subjects. This market has no signs of slowing, budgetary consideration aside for some of the governments. Last time I looked, people want to eat and people want to make sure what they're eating is safe. Now, that's the goal, but there's all kinds of examples to where this is not happening. I was in India at the end of January. Nick and I were in India together, and picked up the newspaper. I just finished -- I mean, I just finished the study in the milk supply in India. By the way, India is the largest producer of milk in the world. 70%, 70% of milk that was tested was contaminated. Okay, that only happens in emerging countries. Well, did you read the newspaper a few weeks ago that orange juice coming from -- orange juice import from Brazil came into the U.S. food supply. The FDA realized there was advanced fungicide in the orange juice that you were about to drink and put immediate stop to importation. So these issues are real, unfortunately, but they do present opportunities for Agilent in terms of how we go forth, how we work with the right people in these countries. And I have an example I'll share with you in a minute about that. So great market, shows no signs of slowing.

I mentioned earlier these outbreaks. We really want to be the company to be called on, to be out there proactively working to help solve these really difficult issues. Perhaps you remember the Gulf Willow [ph] crisis a few years ago. Big concerns about whether or not the seafood coming out of the Gulf would be safe to eat. We worked -- Agilent uniquely worked with the FDA and the Federal (sic) [Food] Emergency Response Network, FERN, that come up with a method to test seafood. It used to take days, through our technology our sample prep, our mass spec, I won't go to all details of the application. We were able to get a fourfold increase in flow-through. They can now run and test thousands of samples. By the way as a commercial opportunity for us, we sold out 40 systems. And then we actually -- but more importantly, we were able to reassure the public the food that they're a eating out in the Gulf was safe and that industry was able to remain more vibrant.

I'd also point to, again, this technology story. We have the broadest technology portfolio across all application needs in the area food testing and food safety. Nick pointed in his presentation to the LP Triple Quad, number one, we have the GC Triple Quad, #1 in this space along with the ICP-MS not shown here. Why should you care about these different technologies descriptions? The take away message here is in this very important market of food safety, we have the leading technology platforms that are used on a global basis across the world.

So I've been talking, pounding this message of market insights, breakthrough with technology and this local presence. Well we know that local presence all comes together at the customer site and the service organization is a key enabler of that. They're there almost every day in the labs. There know what's going on. They're talking with the customers. I’d like to step back a little bit and talk about the services business for Agilent that services both our Life Sciences customers, as well as our Chemical Analysis customers.

Bill, in his earlier comments this morning, mentioned that the growth rate we've been seeing within the Services business has been quite high and you'll see here, just for the last 2 quarters, 17% versus our overall growth of 10% so obviously, our Services business is growing faster than our Instrument business. And I think it also speaks to the transformation of Agilent to have a more reoccurring revenue and our focus on being able to have a clear value proposition to the customer.

But so what's going on here? Why is this happening? So first thing I would to point to is we have an expanded installed base through our M&A work, through our growth in emerging markets. I think Bill called it, "pull through" earlier in this slide but we've been able to have access to a much larger installed base and really aggressively go after that installed base for new business. And we can now go into a lab, in fact, Nick and I were talking about at breakfast today, we can now go in to say a big Pharmaceutical lab and say we can cover all of your technology needs in terms of service. We no longer are simply focused on chromatography and mass spectrometry. We have a much broader portfolio now underway in Agilent and have that capability. But there's more to the story. There is more to this story. Many companies can provide multivendor service and, by the way, this is a big trend in Pharmaceutical industry where they wanted to outsource the management of their instrumentation to some third party. We actually can go in and I think we're uniquely the one company that can do this, because we have an internal R&D team who has been developing business intelligence capabilities. So if you're running the laboratory for a network of laboratories for a big Pharma company, we can provide you all kinds of analytics in terms of asset utilization, the productivity of your researchers, the aging of your assets. What's the maintenance records look like? When I talk big Pharma, I was just at one of our accounts a few weeks ago, this is exactly where they want to go and this is some unique capability that Agilent have and, really, I think speaks to why we believe this wave of continued growth in services is here to stay. It fits right into a global trend we've seen in some of our major accounts.

So the summary here is the same as the opening. It's all about our rare combination of local presence -- I didn't know slide was a build. Our local presence and global scale, that really gives us unique market insights. That's coupled with our breakthrough technology, leads us to having superior customer experience, which leads to us having superior growth in our space.

So with that, I'll close off my remarks and turn it over to Soon Chai who will talk about one aspect of our global scale and leverage as it relates to the supply chain. Soon Chai?

Soon Chai Gooi

Thank you, Mike, and good afternoon, everyone. You have heard from Guy, Nick and Mike talking about each of the business segment within Agilent. So for my session, I will provide an overview of Agilent order fulfillment that supports all of this business across Agilent itself.

Traditionally, Agilent have 2 distinct supply chains; one, supporting the Electronic Measurement products and the other supporting Life Science and Chemical Analysis products. Recently, we have established a central order fulfillment organization and this is the organization that will support the end-to-end supply chain process from order placement, procurement, manufacturing, engineering and all the way to shipment to customers. This integration of supply chain, in fact, allow us to move to the next level of excellence. Allowing us to leverage the skill and scope of Agilent itself, enabling us to harness our global purchasing power, allowing us essentially to maximize our global supply chain, especially in Asia and also to harness the breadth and the depth of our engineering capabilities.

Now, supply chain excellence has always been our top priorities. And I think Ron has mentioned that it is one of the key factors that drive successes in EMG. In fact, in FY '11, the gross margin for EMG was about 58.4% of gross margin. And this is achieved through a couple of key initiatives. We streamlined the manufacturing footprint to 3 major sites. We have a primary manufacturing hub in Penang, Malaysia but we also have 2 technology manufacturing center: One in Santa Rosa, California and another in Colorado Springs. Okay?

Secondly, we also maximize the use of our Asia supply base. And this is due to our long presence in Asia. In fact, we are very well entrenched in Asia. We have in been in Asia for close to 50 years. We have in Japan in early '60s. We have been in South Asia in early '70s. We have been in China in the '80s. And this long presence allow us to create a very vast and strong network of supplier base. And on top of that, we also have developed extremely strong organization capabilities, capabilities that allow us to create strong supply chain management team, allowing us to create a strong engineering competency team. All right. So essentially, the net results, we believe that we have developed a very efficient, flexible and responsive supply chain, a best-in-class supply chain that have also gained many external awards, as you can see from the diagram here, okay?

Now building upon the successes and foundation of EMG, we are now leveraging a lot of those capabilities into Life Sciences and Chemical Analysis growth. Firstly, in the area of manufacturing site consolidation. I think Nick, Mike and Guy has already talked a little bit about it. It in Penang, beyond just the EMG products, we now have NMR console, we have PCR, that's now being built in Penang. Recently, we launched and built the first spectroscopic products, this is transferred from Australia. And in fact, I think there was a question early on about how seamless the transfer is. It took us 3 months to move a product from Australia to Penang, okay?

In Singapore, we have the LC/MS Manufacturing and we also have the GC Manufacturing in Shanghai. Now this consolidation of manufacturing hub in Asia allow us to leverage a lot of our Asia supplier base. Effectively, the manufacturing footprint for LSG and CAG will have volume manufacturing done in Penang, Shanghai and Singapore. And value manufacturing that will still be done in Little Falls, Delaware and also in Wahlberg [ph] in Europe. So again, I think there was a question about risk, what is the risk mitigation? We are not putting everything into one specific site. We are complementing the strength of each site and we still have a very diverse global manufacturing footprint.

Now to further optimize the supply chain, we are also in the process of outsourcing some subassemblies, so this will reduce vertical integration, improving variability. We are also streamlining our logistics and distribution process. Another key area of leveraging is the utilization of the electronic and mechanical expertise that we have a lot in EMG. How do we move that expertise to LSG and CAG for cost optimization and also, in some cases, for product enhancements, right? So overall, I'm glad to report that the gross margin initiated for LSG and CAG are very much on track.

Now if you take a step back, Agilent produces a very wide range of products as you may have gathered after listening to Guy, Nick and Mike. We produce a handheld instrument that's used in electronic test installation and maintenance. We produce RF microwave instrument that's used in wireless and communication infrastructure. We produce a whole range of analytical instrument used for food testing, drug discovery and so on, right? Essentially, what it means is that we produce high technology, high-value products that essentially touches almost the 3 domain of science: Electron in the world of physics, molecule in the world of chemistry, DNA in the world of biology, right? So within this context -- within the context of Agilent products, when we talk about order fulfillment excellence, it really encompasses 2 pillars. The first is operational excellence. So these are the very typical supply chain activities. It’s about sourcing strategy. It's about where do you locate a manufacturing sites. But there is another element that's extremely crucial for the industry, for the product that we have. And it's really all around engineering excellence. It's all about harnessing the breadth and the depth of our capability. It's all about using the [indiscernible] capabilities to increase the -- or enhance the product features, extending the product life, some of our product last for a long, long time and using the capabilities to improve on the cost. It is also about leveraging the capability across the 3 businesses. For instance, LNG [ph] is utilizing some of the RF microwave technology to be used in NMR console, right? We're using some of the thermal technology that we learned from semiconductor industry, applied to PCR, for instance. We're using electronic and mechanical knowledge that can be used in order to [indiscernible] medical instrument in CAG. So those are the leveraging that we intended to accelerate as we go forward.

Last but not least, the other element is that Agilent produces a multitude of new products. In FY '11, we launched more than 35 NPI, new product introduction. So to put in perspective, 35 products if translated into month is almost 3 products every single month. So essentially, we need to have a supply chain and the engineering capability that is able to support this continuous stream of new products and also technology. So going forward, Agilent is well-positioned to maximize the power of a premier measurement company leveraging on the world-class supply chain, leveraging on our engineering powerhouse. That will bring us to the next level of excellence.

So with that, maybe let me hand it over to Ron to lead on the Q&A. Thank you.

Rodney Gonsalves

Okay. We're a little bit ahead of schedule so we have a chance to answer more questions. So, it looks like we have one in the back, please. We're going to give you a new microphone over here to use.

Unknown Analyst

I wanted to ask a question on EMG. Specifically, maybe not so much strategic, but I think the elephant in the room is just kind of visibility after the first quarter and kind of what you're seeing going forward right now? So maybe you can help with the benefit of hindsight now, since you've had some time, just in terms of the shortfall from China and from Europe on the handset business -- excuse me on the Base Station business and how you see things playing out now and kind of looking forward you've had the benefit, hopefully, dig into this issue a little bit more?

William P. Sullivan

Sure. We work very closely with customers. And obviously, develop a sales funnel and we have particular conversion rates and we watch that very closely. Whenever there is a change in the marketplace, the first thing that we would see is it that we would see the conversion rate drop as people push out their purchases. And that's what we saw. It wasn't that our funnel had shrunk and where all of a sudden the business opportunities didn't exist, but we saw things start to push out. As we look into Q2, we're seeing our funnels grow, which is really nice and a good indication. But it doesn't mean anything until the conversion rate happens and people start buying. So as Bill had mentioned previously in the RF component area, as well as in the base station area, we're hearing some good news in the reports that people are going to start investing. But we're just looking at the orders when we say things are relatively flat. The good news is the handset business is very strong. This is a very long-term macro trend that we see, and we expect to report positive revenue growth as opposed to negative revenue growth last quarter.

Unknown Analyst

Nick, a couple for you. First, a quick one with your move over to Singapore, no change in role?

Nicolas H. Roelofs

No change in role and some expanded opportunity to take Agilent into some of those markets.

Unknown Analyst

Okay. And then, you have a nice market-leading platform in Next-Gen Sequencing sample prep. I guess really the question I have is that enough for you in the long time? You talked about your R&D investment and partnership with EMG. One of the players in sequencing uses semiconductor technology today. The next big thing seems to be nano port-based approach which, I believe, you have access and invested in the nano port approaches, yourself. At what point should we think about you moving begun to adjust the front end in sequencing?

Nicolas H. Roelofs

Yes. So there is a lot of opportunity for us in front of a sequencer. So right now, we're still doing partitioning that space. There's a lot of adjacency in terms of the actual sample prep and grabbing the cell and turning the cell into something that then use to extract the DNA and sequence. And so we have actively moved in that direction with automation with other components. So there is a lot of room there. Second comment is, it would be our belief that the partitioning experiment with expand into diagnostic. And so there is an opportunity there for us to think about how we go in that direction. We continue to be agnostic to the sequencing platform. And so yes, we have access to certain technologies, yes the labs guys do lots of invention. We're certainly always thinking about can we get ahead of the curve with a big leap? But right now, we're agnostic to sequencing platform technology and not unhappy with the position we have.

Unknown Analyst

Just 2 questions. One for Guy and one for Nick. First off, on the mobility team, certainly interesting to watch the smartphone market and all those trends there. I'm trying to better understand, as you look at your growth assumptions if you could maybe quantify the importance of mix versus volume in the testing marketplace and, specifically, I think coming out of the conference in Barcelona, one of the themes that our guys picked up on was the concept that, I think, QUALCOMM put forward regarding the increasing density that these wireless networks will have as the data throughput goes up. So I think QUALCOMM was talking about 1,000fold increase in data usage and you have these much higher density networks that have the small cells, I think, is what they called it. So just, maybe how does theme map out the increasing volume for wireless testing? And another one for Nick.

Guy Sene

Well, let me start with this part, obviously, and you're right, it has been one of the major topic last week it was about this heterogenic way of building the infrastructure, the large base stations are one way. But to get more bandwidth available, you need more hotspots if I can tell it this. And obviously this semiconductor vendors or the chipset vendors would love to have many, many, many base stations. So there is still a lot of debate going on this [indiscernible] to be made, because clearly the technology does not allow this easily. You need to be able to go from one large base station that obviously has a lot of power to another one that does not have a lot of a power without losing the signal as you go from one to another. And our technology like LTE-Advanced will start helping this. So to my point is, it's still very early in the process and I would count this more as early R&D investments than any more forward manufacturing part of our business so far.

Unknown Analyst

So if I could just draw back to your business and your growth assumptions. It sounds like more of a mixed driver for your business over time, rather than there's an absolute volume increase in testing, like based on the same, specifically?

Guy Sene

It could be. But again the smaller light radius [ph] where some of the companies call it, at this moment, may require the same amount of testing than a big base station. Again, this type of our products are highly regulated. You cannot just do whatever want in a spectrum and this basically could mean the same amount of test equipment needed even for smaller radius. Obviously, that's not what the industry wants and we currently are working on some test scenarios to try to solve that.

Unknown Analyst

Great. A very general one for Nick and then I'll let you go. On your thematic views for how purchasing for the lab is evolving and this whole idea of the CIO level decisions being made rather than just the individual scientists. Maybe if you could walk us through, from a go-to-market strategy, how your sales pitch to the lab is evolving, do you spend more time talking to those level executives when it comes to capital purchases or are the scientists still incredibly important in terms of deciding ultimately, which piece of equipment ends up in the lab?

Nicolas H. Roelofs

Is that directed to me?

Unknown Analyst

Yes.

Nicolas H. Roelofs

I think the answer is what the CIO or C suite customer does is give us good insight into where we're going to deliver the product. So that could be a customer sitting in France who is going to close down their R&D lab and move it to Korea. The scientists that are actually the people that are the senior people using the products are the ones that specify the capital equipment. So we try to do both. I spent a lot of time on the plane. My direct people spend a lot of time on the plane, and we're trying to attack where are you going to build the next lab, what type of investment are you doing and then we try to work hand and glove with our sales team to make sure that we've got the technical education of the customer on our capability because the scientists are still making that's leading edge technology decision.

Unknown Analyst

On EMG, a couple of things. Can you talk about where you are in the integration path to a greater amount of distributors selling your products? And then how -- does that play into your 40% incrementals as you go to even more variable costs there? Or what are the levers might EMG have to get 40% incrementals even on lower sales or moderate grade, with your gross margins already being quite high. Can you describe a little bit more what might be available to EMG?

William P. Sullivan

I'll start of the incremental and then you could finish up the other piece. So as I mentioned earlier, for the last 2 years, EMG has grown $1.1 billion and delivered $740 million -- $749 million on incremental operating profit, about 65%. That but that's unsustainable and you may have seen on my last side, incrementals of 34%, which differ from a Didier's slide, which showed 20% to 42%. Didier is talk about a specific one -- plus or minus 1 Sigma. What I was talking about is the expectations of each of the 3 groups. So there's an expectation from 30% to 40% depending on what's going on that. But I really believe in EMG, the team has done an excellent job where, over the last 24 months or 2 years, orders are up to 50% and headcount is down 5%. So that has produced unbelievable incrementals. But I don't think that's sustainable for the long period of time. As Bill mentioned, our investment in R&D is important. We see opportunities that are out there, granted there's more leverage that more people have consolidated on LTE versus going with different types of technologies in the past. But the incrementals in EMG will get more down to that range that we talked about, that 30% to 40%, and particularly on the 40% end as opposed to significantly north of that. So Guy, I don't know if you have anything to add.

Guy Sene

No. I would just add that we also designed these products and you'll see the example of [indiscernible] for the channel. So we have a pricing strategy and design strategy to make sure that we take into account the overall cost envelope in this case and it's part of the overall goal for EMG.

Unknown Analyst

So you already know what your migration is? Or is that pretty much come to know...

Guy Sene

No. I would say the current mix that we have is a mix that I feel very comfortable with.

William P. Sullivan

We have roughly 25% of our products are sold through the channel in that area and it goes up or down at 2% to 3%. One of the key relationships, as Mike has talked about, is being close to the customer, understanding their problem, demoing their problem and going forward. So as you go higher and higher in the product line, our direct local control and, basically, our on the street presence is a huge advantage. Now as we bring our distribution capability up more and more, they may be able to move that number a little, but it will not be a dramatic shift like you've seen over the last couple of years.

Unknown Analyst

My question for you. How should we read your move to Singapore from an organizational standpoint? What does it mean from that organization in LSG? And secondly, it seems like the center of mass when it comes to the potential market opportunity is still Western-focused and given your strategy around driving penetration, are you moving away from that, where the bulk of the market opportunity exists today?

Michael R. McMullen

Yes, thanks for the question. You shouldn't read my move as anything other than there is a huge opportunity for Agilent in Asia and we have seen a continued movement of Life Science customers specifically and of all customers for Agilent in general, into the region. And my own prediction is given the investment strategies of those countries in academic and government, as well as the secular trends towards better therapeutics and regions of the world, being not only the emerging markets around Asia, India, I included in that equation, are really going to be the dominant regions in 3 to 5 years and we're just trying to get ahead of it. So my own move there is to get ahead of it. Secondarily, I spent 35 weeks traveling last year, so I can spend 35 weeks traveling this year with my home airport being Singapore as opposed to San Francisco. So there's no lack of attention and focus on my own personal part or my team on penetrating the academic, government world that we've worked on or following our Pharma customers as they migrate.

William P. Sullivan

He spends 10 weeks in corporate and he's going to spend 10 weeks this year. So, rest will be on the road with everybody else. There's some questions upfront too if we could mix it up.

Unknown Analyst

Just a quick one, Ron and Guy, if you could talk about the relative size of the base station exposed business in communications versus the handset-focused business and what's Agilent's position competitively in the handset space?

Ronald S. Nersesian

Well, the way that I could answer is, last year, we mentioned that the handset is about 25% of the overall segment. And the fast we go and as of the life cycle goes, usually you will see first investments in infrastructure and then it's going to move more into handset with more investments. So I would say the shift is happening and there's probably more in the 30% now into handset, compared to the rest of the business.

William P. Sullivan

Another interesting data point that may help. At first, you can't turn on the first cellphone unless there's some type of infrastructure. So there is a wave a pop in the infrastructure. Over the past 2 years, EMG's communications business has grown 65%. And we saw a lot of base station growth. Now there is a little bit of cooling off as we see. But as you know, if you're an ATE, LTE4, 4G subscriber and you ordered an iPhone, being an iPad3 yesterday, you're going to be very frustrated because the world is not covered yet. So there will be continued investment.

Unknown Analyst

Maybe just building, Ron, off of the comment you made in sort of the cooling-off and this is for Guy as well. There was a number of different industry conferences recently where a lot of the communication vendors and other technology vendors were there. There has been a lot of talk of sort of this pause in market. And everyone is sort of assumption of a sort of a second half of this year recovery, whether that sort of a work down an inventory or other sorts of just CapEx planning. And if you think about sort of the pace and sort of these types of pauses and this explosive growth and the different trajectories you've seen in this cycle, in a some of the key mega themes that EMG versus sort of prior, how does it sort of compare and these pause periods that you get sometimes when you’ve got inventory or other changes in the macro? How historically, the time length that they last and sort of how you get the sense that we're actually going to see the other side of that curve?

William P. Sullivan

Well, we've seen pauses for 2 reasons. We've seen it on the capital side where there isn't enough capital, where companies are flushed with money as we saw in 2009. And that pretty much puts the brakes on everything. The other type of pause that we see is like at the end of the 3G R&D or even though a lot of the handsets are made, are 3G, roughly 50% of them and still they haven't to migrate up, the R&D investment in that is not as expensive as it used to be. 4G is not that case at all. 4G, there will be continued growth. So that's why we believe it's a pause. Didier had shared without you a change in our GDP growth rate, we're looking at the average of the world GDP growth rates going up around at 3.4% and 3.7%, somewhere in the second half and increased from the first half. That's built into our plans, it's not an astronomical shift up, but that's what we think will start helping this pick up a little. And people can't pause that long because we've seen players that have paused during downturns, lose immense market share and never come back in the industry. So when you see people such -- some of the players that have that very good market share growth, it continued the R&D investment. So that's why we're pretty confident that it's a pause, because the big macro secular trend is still there. We're not at the end of the cycle and the competition is fierce.

Unknown Analyst

And maybe just a quick one for Nick. Whenever I see large or mid-cap companies around healthcare tools sort of through up molecular diagnostics is sort of an emerging growth area, I'm always a bit torn; great markets, great growth but they're incredibly competitive and sort of getting into those markets is always a challenge. Even when you buy it, I mean how do you sort of balance the areas where you think you can get the return on capital or the long-term kind of market share and presence coming from where you are today versus sort of the growth and other opportunities there that's obviously, want you to focus?

Nicolas H. Roelofs

Yes. It's a great question. First of all, what we are not, and so you've kind of pointed at, is we are not deeply confident in registering products. We are not good at educating docs. We don't have that channel. What we are doing is we are methodically building those pieces internally, organically, and the reason we're doing it methodically is exactly what you said. It's very seductive to look at that diagnostic space. There is a lot of people who becomes seduced in looking at those companies. That seduction translates into very high multiples and looking at those assets and we are not going to do something stupid financially. So we have a methodical organic path and that's why we've also been very conservative in speaking to you about it. This is not going to become 10% of Agilent in a horizon that I can talk to. This is something we're working through. We know that we don't know how to deal with reimbursement. We're not naive but we're also not trying to hype up how we get there. And if opportunities come up inorganically, we'll certainly look at them. But they have to return on our ability to manage them.

Unknown Analyst

Two questions, one to Guy and one for Nick. Recently, Teradyne aggressively went into the wireless market. Does that change the formula since they historically have very strong testing capabilities? And the second question for Nick is the trend to outsource that CRO, the first phase is to the Pharma guys cut back their labs and equipment, everything and becomes more efficient model where the CRO doesn't need all the equipment. They need less equipment than the original players?

Guy Sene

So let me start with the first one. Yes, recently Teradyne acquired LitePoint, that is a company focused on the wireless LAN testing, mostly. And clearly, we're competing in this space. So we see and we intend to win when we go after this type of markets.

Nicolas H. Roelofs

And in your serial conversion thing, first of all, we're well into the cycle with Pharma moving the CRO, so that's a trend that's well out there. From your macro explanation, you're absolutely right. What tends to happen is the Pharma Ted -- the CROs tend to consolidate research for a bunch of Pharmas and it's always a theory and it probably has some truth to it. From an Agilent point of view, what we're seeing is that means 2 things happen; the research location relocates and there is a new technology wave coming. So what the big Pharma guys are doing is they're stopping the research, usually in the East Coast United States, would be an example, and they're relocating in that research to a CRO, let's say, in India or in China. From our perspective, we've got the new technology to win on that technology relocation wave and any time you dis-intermediate the current customer’s sales from the customer, we have an opportunity. And remember that in most of the LST technologies, we are not the sheer leader. So it actually creates an upside opportunity for us as this dislocation of the existing sales rep occurs when the New Jersey Pharma moves to India and that's what we're counting on and we've been materially capitalizing on.

Guy Sene

And just to add one more point on the earlier one. What we differentiate clearly is that we have solutions for, again, the whole life cycle. So we start from R&D up to manufacturing, that's a very different from what the company you mentioned from.

Unknown Analyst

So just looking, at first question to Nick, I think one of the interesting things that you've mentioned in your presentation was something you couldn't have said 5 or 7 years ago was that you're going to be competing on the dollars of R&D spend in your business. So when you are looking at doing that right now, can you sort of give us some color as to how that translates not so much into growth but the fuller portfolio and the higher R&D into pricing? So what have pricing trends been like over the past 7 years, are there any changes? Are you getting stability there? And then the second question would be more broader to across the businesses. You've seen very volatile pricing trends and electronic measurement 7, 8 years ago and then when there's a slowdown, as you're portfolio from an overall company perspective has gotten -- you've gotten out of some volatile pricing businesses or where the pricing pressure is the greatest. How has that changed in the overall business portfolios, pricing expectations, going forward, across the 3 businesses? And as the recurring revenue stream has increased, what are the changes that, that is creating as well? In your [ph] business?

William P. Sullivan

So I'll startup and then I'll move over. First on the electronic measurement side, as we've seen a little bit of pause, we see some heavy competition and a little more discounting. So I'm very convinced with Soon Chai Gooi and his team will do is to go ahead and deliver margins and to try to deliver even margins that are higher. But we think it's appropriate to model and it to expect that EMG will continue to maintain that margin at the 58% range, 58% range. On the Life Sciences and Chemical Analysis range as we've stated before, we have 5 points of improvement, we've already achieved approximately 1 point and we have a pathway to deliver what we have committed to before forth. But I would hate for you to all of a sudden get really excited about Soon Chai's and not considering the pricing factor, which we believe will maintain our high margins in EMG and make sure that we're also leading so we can generate more top line growth and more EPS.

Nicolas H. Roelofs

And then in the Life Science space, I mean, it was the tenant of what at that time was the LS and CA or biomedical group to be a fast follower and tenant had a certain lens of R&D investment that wasn't outspend the competition. We made a conscious decision as a company to enter the Life Science space, about half a decade or a little more ago, about 8 years ago, and in that conscious decision, we said that if we're going to enter this space, we have to enter this space to be a technology leader. So that's where you heard my comment. If you make the conscious decision to be the technology leader then it's just simple math. Our guys aren't smarter than their guys. We don't have necessarily more of them unless we outspend them dollar for dollar in similar technology and then hopefully we've spent equal dollar to dollar and then we got the brighter guys with a better organized team. That's what we hope to do. We are now at a point where we are technology leaders in many, if not all, of the products we have although. And while we are not market leaders, we're technology leaders. When you were a technology leader, you not only have your own pricing control well underhand because your customers want you technology but you also create stability in the marketplace for pricing because you're moving the overall market up. So we've seen a lot of stability come in pricing and Life Science, especially in our category of products and we're very pleased at how that's now translating to gross margin on top of the benefits that we'll get out of the organization for the order fulfillment.

William P. Sullivan

And also, if I could just give you a sense of our pricing structure in the aftermarket; you have to remember our customers have made very significant capital investment in their laboratory instrumentation. So what's most important for them in the aftermarket is quality and capability. So can you provide the service that I need? Do I get the quality consumables? So that's to give sense of maybe the pricing dynamics in the aftermarket.

Unknown Analyst

And Ron, just a follow up. If you were to quantify the kind of pricing declines that -- the average pricing declines, I know right now it might be slightly above average because of comparative issues. But the average pricing decline over the past 10 years, has the trend been moderating pricing declines or has been fairly steady in the -- like comparable to the world of technology?

Ronald S. Nersesian

When we see a new technology come out, the prices are here and then they decline. And it really depends on the life of the product. So we see power products that are used in basically every system where the prices remain relatively steady in them and the product lines last 10, 15 years where we have products. We have other products where oscilloscopes were the high-end moves and you see the prices decline more quickly. What I'm talking about, most recently, is in the point range, 1 or 2 points, it's nothing that dramatic. But what we're also doing is shifting our portfolio to more and more software, which have 90% gross margin and by shifting our portfolio to software, it's very strong, and then doing the generic thing that we talked about which is moving to all of these annuity businesses, our stable base, even though it's still about 25% of our business, it continues to grow in dollars and you could just calculate off the EPS that you're getting from that business and it makes dividends and things like that a no-brainer.

Unknown Analyst

Two questions. One, I think easy, the other maybe a little bit longer. The first question is I think you for you, Mike, in your slide... In your Slide 55, you referenced 17% growth in BAM services but at least in my book, the dollar figure was missing from that slide. I thought it was just my book. Could you just remind us, is the dollar figure the same $1.7 billion...

Michael R. McMullen

No. It's actually a subset of that. And I think in the most recent JPMorgan we quoted a number, I think, it was around about $659 million in our Service business. So that would be a component of the number that Ron had spoken about.

Ronald S. Nersesian

The total number I mentioned was $1.7 million, which includes the services, the consumables, the reagents in all 3 groups. It's approximately $400 million in EMG and approximately $1.3 billion in Life Sciences and Chemical Analysis, put together. The growth...

William P. Sullivan

I was going to say that $1.3 billion is split evenly between services.

Unknown Analyst

Right. Okay. So $659 million, which is a subset of the $1.7 billion. And it is exclusive to the 2 segments, the sub segments. The maybe longer question is across all 3 businesses, you've talked some about distribution and the importance of distribution and how you can both directly through direct and indirect distribution be closer to your customer. But I don't actually know what your distribution patterns are across the 3 segments, how much is direct? How much is indirect? How you want to change that? Can you just each of the 3 segment leaders, give us a cook’s [ph] tour of distribution?

Ronald S. Nersesian

Before each of you do that, I just want to say it doesn't get us closer to the customer. It gives us more reach. So as Bill has talked about market reach, we can focus our field engineers where there is the best opportunities, be it in the academic and government segments, be it in the large wireless providers for customers that are making large purchases. But you can imagine when a field engineer could have a quota anywhere from $1 million to $10 million depending on the type of account [indiscernible] they cover, they may not be going after the small or the lower cost products. Oscilloscopes range from $1,000 to over $200,000 apiece. So that's why it's so important. And with that, I'll turn it over to each of the 3 to talk about.

Michael R. McMullen

Sure. So as Bill mentioned earlier in this presentation, the CAG business historically had a mix of indirect and direct channels. It's probably about a 60/40 mix right now, direct, indirect, moving more direct as we expand our presence in emerging markets. So our focus is in emerging markets, is to build out a much stronger and direct presence with the customers. So you'll see that ratio move up a bit more to direct 60/40 mix right now.

Guy Sene

On an EMG, as we've said earlier, the mix is 75-25 and plus or minus 1 and, obviously, very different from the countries we're in. In some countries, we're completely indirect and in other countries, like China, we really like to keep the direct channel source. But globally, the mix would be 75-25.

Unknown Analyst

75 direct?

Guy Sene

Direct. Yes.

William P. Sullivan

And for instance in 2008, we were 8% indirect and now we're talking roughly 25%. Just to give you a calibration.

Nicolas H. Roelofs

And then in LSG, to be clear, when we created the Life Science channel, we selected geographies that have high-density of Life Science customers. So in the geographies that the Life Sciences channel covers, we're about 80%, 85% direct and that's to get close to the customer. The countries that the Life Science channel does not cover specifically, which are lower density or more remote are exactly the comment Mike made. They're a joint district and they're about 60-40 and were moving more direct as a team and then when we get enough density, we pull them out the Life Science and then that even gets more direct to get close to the customer.

Rodney Gonsalves

We have time for one question and then Bill is going to conclude with the wrap up.

Unknown Analyst

If I could just try to tie things up and reconcile some of the numbers we've heard today. So we know fiscal '12 operating margin guidance 20.6%. We talked earlier we've heard about 1 percentage point gain each year based on the model, right? So if we think out 3 years, Ron, you had mentioned an $8.5 billion sales target or level, which is right at the heart of the model over a 3-year period. If we think about that 1 percentage point gain, it would imply an overall operating margin in excess of 23%. And if my math is correct, that would put Agilent at about $2 billion of operating profit. Is that the right way to think about the outlook over the next years?

Ronald S. Nersesian

I think as time moves on, we're going to go ahead and look at, obviously, where we end up in the 30% to 40% range for the company and we'll continuously update you on that. We have to look at our competitive situation. In some markets, 3% R&D is enough. In other cases, where there is no revenue, maybe 50% R&D. So we're constantly balancing the portfolio, constantly putting our bets where the markets are. These 3 gentlemen do not get equal funding for equal projects. They're all in support of the bigger things. So if you want to model the specifics afterwards, I would recommend you talk with Didier and he could explain it to you.

Unknown Analyst

And just one real quick follow-up. So it does not include any incremental bolt-on M&A or potentially larger M&A?

William P. Sullivan

Correct.

Ronald S. Nersesian

Okay, with that we'd like to turn it to Bill. Thank you.

William P. Sullivan

Again, thank you all very, very much for your attendance, your participation and all the great questions. So really 3 things I'd like to leave with you. First of all, in this a macro-environment of uncertainty, you saw the number from Didier, roughly this 3% to 3.5% growth rate, I personally believe that it will continue to downgrade a little bit as we move forward. But at the end of day, the message you would take, I think from the executive suite in Agilent is that 2012 is probably a muddle-through year. Someone has asked in the break, if I was actually a little more upbeat than last year. In fairness, probably so. I must say I'm frustrated with the political chaos in Europe and the U.S. but nevertheless, it's a muddle-through story globally barring some sort of default in Europe or some problem in the Middle East. But overall the message is that we're -- we think we've got a great strategy, and we're going to continue to fund it and continue to execute. The second message I leave with you is that you've got to see the new expanded team under Ron. You know Mike and Nick very well. You know Ron and his past role, but being introduced to Soon Chai and Guy, I hope it came in a way that we have a team that we believe that we can execute on what we said. We have a great track record of execution. I am very, very excited about the new opportunities that this team has moving the company forward. And that third take away that I'd leave with you is that we raised the bar for this team. So it's very easy for Didier and I, "Hey, Ron you guys take over the day-to-day operations of the company and, by the way, your ROIC target now is 25, not 21." And so again, this is a company that's absolutely committed to not sit on its laurels and to continue to aggressively drive value for our shareholders. Underneath that, I think that you saw that our variable cost model, coupled with our operating model, is incredibly powerful. We do have a big knob where we can control spending very, very easily. And so as a result of that, we are very, very confident that we have the mechanisms in place to be able to deliver the type of incrementals, the corresponding cash flow and the corresponding EPS all tied back to the revenue model that we shared with you.

So with that, thank you all very, very much. And again, have a good rest of your day.

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Source: Agilent Technologies Inc. - Analyst/Investor Day

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