Agilent Technologies, Inc. (A) Q2 2010 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2010 Agilent Technologies Inc. Earnings Conference Call. My name is Yvette and I'll be your operator for today. [Operator Instructions] I would now like to turn the call over to Ms. Alicia Rodriguez, Vice President of Investor Relations.

Thank you, Yvette, and welcome everyone to Agilent's Second Quarter Conference Call for Fiscal Year 2010. With me are Agilent's President and CEO, Bill Sullivan; as well as Vice President and acting CFO, Didier Hirsch. Joining in our Q&A will be the Presidents of Agilent's Electronic Measurement, Life Sciences and Chemical Analysis Groups, Ron Nersesian, Nick Roelofs and Mike McMullen. After my comments, Bill will give his perspective on the quarter and the overall market environment. Didier will then follow with a review of financial results, and after Didier's comments, we will open the lines and take your questions. In case you haven't had a chance to review our press release, you can find it on our Web site at www.investor.agilent.com. Please note that we have moved the Business segment financial tables to the schedules accompanying the press release. We are also providing further information to supplement today's discussion. After you log on to our webcast module from our Web site, please click on the link for Supporting Material. There you will find additional information, such as our revenue breakouts and historical financial information for Agilent's continuing operations. Also in accordance with SEC Regulation G, if during this conference call we use any non-GAAP financial measures, you will find on our Web site the required reconciliation to the most directly comparable GAAP financial metric. Additionally, I'd like to remind you that we may make forward-looking statements about the future financial performance of the company. These involve risks and uncertainties that could cause Agilent's results to differ materially from management's current expectations. As a result, we encourage you to look at the company's most recent filings with the SEC to get a more complete picture of all the factors at work. The forward-looking statements, including our guidance provided today during the call, are only valid as of this date, and the company assumes no obligation to update such statements as we move throughout the current quarter. Lastly, before I turn the call over to Bill, on Friday, May 14, we announced the successful close of our $1.5 billion acquisition of Varian. While our prepared comments today focus on Agilent's Q2 results, we will be happy to provide more information around the acquisition during the Q&A portion of the call. Now let me turn the call over to Bill for his comments.

Thanks, Alicia, and hello, everyone. In a few moments, Didier will provide you with an overview of our Q2 financial results. I will provide you with a summary of results, our market perspective and our outlook for the second half of the fiscal year. Agilent continues to capitalize on the global economic recovery. Q2 orders of $1.35 billion were up 31% year-over-year, while revenues of $1.27 billion were up 16% from a year ago. Non-GAAP earnings were $152 million or $0.43 per share. Agilent's second quarter earnings combined with solid asset management enabled us to generate $224 million of operating cash flow. We ended the quarter with net cash of $1.4 billion. All regions grew by double digits year-over-year, led by a 24% increase in Asia Pacific. Growth rates in China have moderated from their record highs but remain in double digits. Overall, Agilent's large and established presence in Asia will continue to serve as a strong competitive differentiator. 41% of Agilent's business resides in Asia, a record high percent. Europe grew 10% year-over-year while the Americas were up 13% from a year ago. From a market perspective, we saw year-over-year revenue growth in most of our key markets that we serve. Our Chemical Analysis business had an excellent quarter. Q2 revenues were up 19% year-over-year as demand continued to improve in industrial and applied markets. All key end markets were up double digits year-over-year; petrochemical, plus 30%; food, plus 15%; and environment forensics, plus 27%. Operating margin was 24%. From a product perspective, our GC/MS, ICP-MS and mid-range GC platforms each grew in double digits. We also had solid double-digit growth in our Consumables and Services, up 21% and 11%, respectively. We expect future growth to be driven by continued focus on food safety, opportunities in emerging markets and expanding Consumables and Mass Spec portfolios. Our Life Science business had a solid quarter with revenue up 12% over last year, up 15% if we exclude the High Court divestiture from last year's base. Operating margin was 14%. Excluding the High Court divestiture, we experienced modest growth in Pharma and Biotech at 4% year-over-year, academic and government revenues grew 11%, sales of LSG products and services into applied markets were up 25% from a year ago. From a product perspective, LCs were up 28% year-over-year with strong worldwide demand. 1290 LCs continued to exceed expectations. LC/MS was also strong, with increasing demand for Triple Quad and in Q-TOF instrumentation. We also saw a double-digit growth in Consumables in our new SureSelect sample product offerings. The biggest story this quarter was our Electronic Measurement business. As you recall from our March investor meeting in New York, Electronic Measurement was the wild card in the recovery with upside potential from our forecast. EMG's Q2 revenues including Network Services rebounded to almost $700 million, 18% growth year-over-year. General Purpose is up 31%, while Communications revenues were down 3% from a year ago. Q2 orders grew a spectacular 44%, operating margin was 14%. Our General Purpose markets continue to strengthen. Industrial Computer and Semiconductors posted their strongest results in recent history with revenues up 56% over last year. Performance is being led by an overall improved economy with strength in Electronics and Semiconductor businesses. Aerospace and Defense was down slightly, driven by softness in the U.S. market but we didn't note any significant change in trends or customer demand. We expect seasonal improvement in Q3. The Communications market was mixed. We saw some sequential growth in Wireless R&D, although it’s down year-over-year. Wireless manufacture is improving with low double-digit growth over the last year and high double-digit growth over last quarter. Demand in Q2 is mainly driven by one-box testers and Smart phones. On May 1, we completed the divestiture of our Network Service businesses. From a product perspective, our core platforms continue to do well. Our PNA-X network analyzers and PXA signal analyzers continue to be well received by the market. High-performance oscilloscopes were strong in the Computer and Semiconductor market. We recently introduced an industry-leading 32GHz Infinium Scope. Moving forward, Agilent’s in excellent position to grow during the recovery. Our continued investment in R&D and our strong global presence are foundations for capturing market opportunities. You may have seen by a recent press release announcing the successful close of the Varian acquisition. Teams from both Varian and Agilent have been developing detailed integration plans for the past several months. We have already launched our initial customer communication. We have also developed a detailed operating handbook for our field in sales operations for conducting businesses post close. We continue to strongly believe we will be able to capture revenue synergies through the addition of the Varian product portfolio. Regarding the integration of infrastructure, our intent is to minimize disruptions over next several months to ensure both Agilent and Varian to focus on operations and customer commitments. Our strategy is to integrate Varian’s core systems and processes into Agilent's operating model. By the end of the calendar year, our plan is to integrate our legal entities, core quote to cash processes, services and support processes, sales and marketing processes, Web environment and begin the conversion of the factories to our ERP system. In addition, we have already established intercompany conductivity and began upgrading network bandwidth to ensure rapid communication and sharing of information. We remain very confident in achieving $75 million of cost synergy over the next 4 to 5 years. In addition, we will reach Agilent's effective tax rate by the end of 2011. Agilent on a standalone in the third quarter of 2010, we expect revenues to grow in the range of 16% to 19% from a year ago. Non-GAAP earnings are expected to be in the range of $0.43 to $0.45 per share compared to last year's $0.15 per share. We're also raising our guidance for the full year. For FY 2010, we expect non-GAAP earnings to be in the range of $1.70 to $1.75 per share, compared to last year's $0.80 per share. These numbers are exclusive of Varian acquisition. We expect Varian to add close to $370 million of additional revenue in the second half of fiscal 2010 starting from May 15. As we have discussed at the analyst meeting, Varian will add approximately $0.08 to earnings per share in the second half. Thank you for being on the call. And now I'll turn it over to Didier.

Thank you, Bill, and good afternoon, everyone. I will now provide some additional color on the second quarter results. First, Agilent overall, then the three segments, and will end my prepared remarks with a review of the third quarter and full year outlook. Please note that my explanations will be focused on the year-over-year variances and I will report the year-over-year top line growth percentages with and without the recent divestitures of Hycor and Network Systems. Also, I will provide guidance on the second half Varian incrementals. Starting at the enterprise level. As Bill stated, we had a strong second quarter. Orders of $1.35 billion were up 31% from one year ago, 28% on a currency-adjusted basis. Regionally, Asia Pacific led all other regions with 35% growth, 30% on a currency-adjusted, followed by the Americas at 33% and Europe which was up 23%, 18% currency-adjusted. Revenues of $1.27 billion were up 16% from one year ago, 13% on a currency-adjusted basis, with all three segments up double digits. Excluding Hycor and Network Systems, revenues were 19%. On a geographic basis, Asia Pacific excluding Japan once again led the way with 26% growth, 24% currency-adjusted, while the Americas were up 13%, 11% currency-adjusted and Europe was up 10%, 6% currency-adjusted. Moving on to the income statement. Second quarter operating profit of $201 million was $134 million above one year ago, $179 million increase in revenues, resulting in a 75% operating profit incremental. The key factors driving this performance were volume-related gross margin incrementals and restructuring savings, which were partly offset by the impact of the restoration of full pay and higher variable pay. Currency had minimal impact on the bottom line but did impact the various lines of the income statement. Turning to the individual income statement line items. Second quarter gross margin at 56.9% were five points higher than last year and improved two point on the volume adjusted basis. And to note, 56.9% is a record high gross margin in Agilent's nearly 11 years’ history. Second quarter operating expenses increased $22 million. Excluding currency, year-over-year spending increased $7 million or 1%, the result of higher sales commissions and higher variable pay. Operating profits of $201 million were up nearly 200% from last year. The company's second quarter operating margin was 15.8%, up nearly 10 points from one year ago and already higher than our mid-cycle target of 14%. Other income and expense was flat from last year. Our non-GAAP tax rate during the quarter was 20% compared to 21% one year ago. And pro forma net income of $152 million or $0.43 per share compares to $0.13 per share one year ago. Turning to the cash flow and the balance sheet. We continue to demonstrate strong discipline in asset management. Inventory days on hand at 91 days were 16 days better than one year ago on $62 million lower inventories. Receivables days sales outstanding were unchanged from last year at 47 days. Given our high profits and strong asset management, total cash from operations for the quarter was $224 million, which represents an increase of $87 million from one year ago. During the quarter, we issued around 5 million shares for $121 million in relation to options exercises. We repurchased about 5.3 million shares or $165 million worth of shares. As you know, our board has approved last November an ongoing anti-dilutive share buyback program to maintain the outstanding share count at about 350 million shares. With regard to our net cash position, we finished the quarter with net cash of $1.4 billion, up $455 million from one year ago. Let me say a word on the $1.5 billion world trade debt, which matures in January. We have an option to extend the current deal in its entirety, but are considering several options to reduce the amount outstanding, or possibly pay it off entirely as early as January of 2011 but no later than January of 2012. Finally, you will have noted that Moody's recently upgraded our credit rating to BAA 3. Now we have an investment grade rating at all three rating agencies, and we are committed to maintaining solid investment grade ratings in the future. Now turning to the segment financial results. Life Sciences' second quarter orders of $331 million were 15% above last year and up 11% on a currency-adjusted basis. Excluding the Hycor divestiture, segment orders improved 18% from last year. Life Sciences’ revenues of $334 million were up 12% or 8% in local currency terms and up 15% excluding Hycor. Geographically, the Americas were up 9%, Europe was up 4%, Japan was up 27% while the rest of Asia Pacific rose 25%. Second quarter operating income was $48 million, up 9% from one year ago. Gross margins held steady at 65% and operating margin at 14% was also flat from one year ago. Segment ROIC was 18%. Looking ahead to the rest of 2010, we expect that second half revenues for Life Sciences will be up roughly 14% to 16% from the second half of fiscal 2009 or 17% to 19% adjusting for divestitures. Turning next to Chemical Analysis, orders of $231 million were up 19% from one year ago and up 14% in local currency terms. Revenues of $238 million were also 19% above last year and up 14% in constant dollars. Geographically, the Americas were up 10% from last year and Europe was up 8%. Japan jumped 46%, while the rest of Asia Pacific was up 28% from one year ago. Second quarter operating income of $57 million was $11 million above last year on a $38 million increase in revenues or 30% incremental operating profits. Gross margins improved one point at 54.5%, while operating margins improved one point to 24%. Segment ROIC increased eight points to 48%. Looking ahead, we expect Chemical Analysis' year-over-year revenue growth of 13% to 15% for the second half of our fiscal year. Finally, turning to Electronic Measurement. Second quarter orders of $784 million were up 44% or up 42% in local currency terms. Excluding the Network Systems divestiture, segment orders increased 52% from last year. Revenues were up 18% from last year or 15% in local currency, and up 22% excluding the aforementioned divestitures. Geographically, revenues were up 16% in the Americas and 17% in Europe; Japan was up 9%, as the second quarter marked a return to growth after several down quarters. The rest of Asia Pacific was up 26% from last year, with broad-based growth across all countries. Electronic Measurements’ second quarter operating profit of $100 million was $122 million above one year ago on $105 million increase in revenues, clearly showing the cumulative benefits of the resizing of this business, with a year-over-year operating profit therefore incremental of 115%. Gross margin rose eight points to 59%. 59% is the highest quarterly gross margin achieved by EMG since the separation from HP more than 10 years ago. Operating margins improved by 18 points to 14%, segment ROIC rose 24 points to 20%. Looking ahead, we expect the market recovery in Electronic Measurement to continue and second half revenue to be up roughly 23% to 25% on an apples-to-apples basis, i.e. excluding the divestiture of the Network Systems business. On an unadjusted basis, the growth for the second half is expected to be in the range of 12% to 14%. Now turning to the outlook for Agilent overall. I will first give you the outlook for Agilent without Varian and then the forecast for the Varian incrementals. For Agilent standalone, we expect Q3 revenues to be about 16% to 19% above last year, or 22% to 25% adjusted for the Network Systems and Hycor divestitures. And we expect Q3 non-GAAP earnings per share to be in the range of $0.43 to $0.45, about triple last year’s $0.15 Q3 earnings per share. For the full year, for the full fiscal year, we are raising our guidance on both revenues and EPS. We now expect Agilent's standalone revenues to be up roughly 12%, or 15% adjusted for the Hycor and Network Systems divestitures. We project non-GAAP EPS in the range of $1.70 to $1.75, which is up $0.05 from our previous guidance. Now to Varian. Even after the delayed close and the required divestitures, we still project that Varian will add approximately $0.08 to Agilent second half EPS on about $370 million of additional revenues, with roughly 70% of the revenues going to CAG and 30% to LSG. With that, I'll turn it back to Alicia for the Q&A.

[Operator Instructions] Your first question comes from the line of William Stein with Credit Suisse. William Stein - Crédit Suisse: The orders number in the Electronics Measurement Group was quite high, the growth was very strong and we've heard a lot about shortages in the electronic supply chain, shortages for components, and in particular, for some semiconductor test equipment. So I’m wondering if this has any effect either relative to what your customers are placing with their orders on Agilent, and also whether it's affecting how Agilent's behaving in the supply chain and ordering components.

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

Yes, Will. Overall, our deliveries are getting longer on certain products, but we have not seen it affect our order rate or an order cancellation rate. We continue to make progress to bring in some of the deliveries that were lengthened out due to this quick market recovery. But overall, we built $75 million in backlog in Q2, and we will start to ship some of that backlog out in Q3 and bring down the order-to-revenue gap. William Stein - Crédit Suisse: So how far in the future does your backlog extend at this point? Is it well beyond a quarter for a lot of the backlog today?

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

So our policy’s just to book orders at six months in advance moving forward so typically, one month’s orders can potentially be next quarter's revenue except for the issues that Ron talked about in terms of continue to work on getting sufficient components in-house. Again, EMG continues to be the big wild card in upside on this. It's hard to forecast continued 50% order growth. If it does, we'll have higher forecasts in the future. William Stein - Crédit Suisse: Just wondering if I can dig on this issue just a little bit more. What are you seeing in terms of lead times for components today? Are you seeing lead times continuing to stretch or has it stabilized? Are they starting to come back in?

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

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

How much is it driven just by the really strong volume increase, and how much is due to further savings that you had falling in the quarter? I guess we're looking at sequential pickup in incremental margins?

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

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

Switching gears to Varian, where they’re taking so much longer than anticipated. Did it really have an effect on your original plans and compared to when you originally announced the acquisition? And then the $25 million of synergies, is there more to be had there, it's just a little too early to say?

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

Your next question comes from the line of Jon Wood with Jefferies. Jon Wood - Jefferies & Company, Inc.: So, Didier, could you give us kind of an update on the cash flow outlook this year, either with or without Varian, however you want to do it? And then do the CapEx plans change at all with Varian in the mix now?

So no change to the cash flow projections. It's for Agilent standalone, $600 million on operating cash flow basis and $500 million on a free cash flow basis. So no change. And then we are looking at the additional CapEx that will be required with the Varian acquisition, and we'll give you an update going forward. But at this point in time, we are not in a position to give you an adjusted cash flow projection. And clearly, Varian has been cash flow positive in the past, so we don't expect that the addition of Varian will change the overall Agilent cash flow. And Varian is moving to Agilent with over $200 million of cash. Jon Wood - Jefferies & Company, Inc.: This is probably for Nick Roelofs. The one issue we saw in the quarter was the Life Science incrementals were fairly low. Is that related to the High Court divestiture, were there any one-time effects in that number this quarter, Nick? And then what do you expect for the incrementals for the year in Life Sciences?

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

And also as you know, this is the area that we’re investing as a company. It's an $18 billion opportunity. I believe during this downturn we've done a very good job of making the appropriate investments to ensure that we can capitalize our largest market and Nick's organization is where our largest incremental investment has been made. Jon Wood - Jefferies & Company, Inc.: All right, so it’s fair to say it was actually a bit ahead of your internal forecast, it just looks cosmetically different to us from the outside?

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

Your next question comes from the line of Richard Eastman with Robert W. Baird. Richard Eastman - Robert W. Baird & Co. Incorporated: Bill, how does the bookings number and backlog number look in Varian now that you're in there? They were maybe expected to pick up a pretty strong 18-month backlog in the NMR area from some of the stimulus money and packages and demand. Is that in their backlog and do things look pretty firm out past the traditional six months that Agilent would book as backlog?

Well, they do have a large backlog in NMR and that can be a real challenge to the team under Nick’s leadership to continue to work that down. The preliminary data suggests that the backlog is consistent to the revenue number that we have forecasted. I have no doubt during the uncertainty that there has been some reluctance on customers to be able to place orders. Fortunately, I think we are very well positioned to quickly integrate the sales team with ours and to really capitalize on what I believe is a market that is in fact expanding. Richard Eastman - Robert W. Baird & Co. Incorporated: And then just secondarily, on the Electronic Measurement side of the business, within the Communications segment of that piece, of that Group, how do you look at that playing out for the second half of the year? Should we start to see some growth against the easier comparisons, or is that going to be more of an FY ’11 recovery?

A little hard to say what is going to happen in the market. But I will say that we built backlog primarily in the Communications segment. So when you look at the backlog that was built, it was heavily skewed towards Communications and the divisions that ship those type of products. So there is a difference that we see going forward on Communications with regards to growth rate, but of course, we're not counting on a big market upturn from here in order to deliver the forecast that we have given you. Richard Eastman - Robert W. Baird & Co. Incorporated: But we should see sequential growth given the backlog, Bill?

Yes.

Your next question comes from the line of Jon Groberg with Macquarie.

Can you maybe just talk about the pricing environment right now? I guess on both sides of the business, but in particular on the Chemical and the Life Sciences side, I hear that instrument pricing has gotten a little bit more aggressive during the downturn. Maybe you can just comment on what you’re seeing?

Well before Mike and Nick add a comment, I will put my editorial plug in that we continue to reach record high levels of gross margin. We've got the testament to the product offerings that we have had and the aggressiveness that we have had in terms of lowering our manufacturing costs, but Mike?

Hey, Jon, Mike. That’s where we’re seen a level of stabilization in terms of pricing and you may have noticed our margins actually increased a point over last year in operating profit up at a higher rate than revenue. So we're seeing a more favorable price environment.

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

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

I thought we can address that question at the Agilent level. Our gross margin was 66.9% and the year-over-year improvement of five points. When it have been from volume would have improved the gross margin by two percentage points, and that is what Bill has referred to in terms of our ongoing improvement in the manufacturing efficiency and supply chain and all those things.

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

Sure. I would just talk about three different factors. First, discounting as Bill has mentioned. And with regards to discounting, as product availability has lengthened, discounting has been less of an issue. The second issue is with regards to the inherent prices you can charge for your products. And as we continue to focus on technology leadership with our high R&D investment, we're seeing higher-priced products with higher gross margins in general from our top-end network analyzers, our top-end Spectrum Analyzers, and now with the addition of brand-new real-time oscilloscopes. The oscilloscopes that we introduced a couple of weeks ago are the world's highest performance oscilloscopes that deliver the world's highest bandwidth, the world's lowest noise, the world's lowest jitter. All these things that are very critical to the overall market and to end customers. Not only did we introduce those products, we have started shipment on those products to customers and that helps. The third piece is in cost reductions and we continue to have a focus on making sure we streamline our operations. So one, our discounts remain to be managed very well. Two, our product portfolio has more of a performance leadership characteristic which adds higher gross margin. And three, we continue to go after costs to make improvements on the order fulfillment side. And all three of those have led to record gross margins for Agilent and EM.

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

I’ll have both Mike and Nick make a comment on the progress that they’re making on increasing orders and revenue moving forward. That is priority #1, is to leverage what is now going to be close to, if not the broadest product portfolio in the industry. In terms of the cost side, however, though, we are going to aggressively pursue the cost synergies we have. By far, the bulk of that is leveraging the purchasing power that we have as a combined entity. Moving forward, just a 5% cost leveraging on direct materials is $40 million. The teams have identified areas where we can share components across various product lines. We have plans in place to reduce or combine sales offices around the world, that’ll be another $15 million. So we have really done a very good job just today figuring out exactly what we need to do to be able to quickly get costs out of the system without disrupting the system. As you know, during integrations, oftentimes the employees are more worried looking in than versus out, and the message that we have clearly said to the new Agilent employees is that we must recapture the momentum into the marketplace. And so Mike and Nick, why don't you talk a little bit about what you’re doing in that area?

I will make some comments there around the integration efforts and then talk specifically about some of the segments. By the way, we talked earlier about the delay in closing. That, in fact, has been an advantage as relates to the integration planning. I just returned from Europe, for example, and we have an opportunity really to get ourselves well-positioned. The priority focuses on the field and the customer so I think we're well-positioned to capitalize as Bill mentioned, on the top line synergies of staying close to the customer and then, Jon, when you get into some of the details you’re going to see later on that the business is in varying degrees of shape in terms of what segment you’re in. So the vacuum technologies business, for example, which we will continue to run as a standalone entity much as Varian did, continuing to do quite well and as you saw in the recent announcement, it’s really capitalized on return to market growth. Consumables is a great opportunity for us. Priority will be the first place we’ll actually be able to integrate some of the Varian portfolio into our Agilent sales force so we have a number of short-term plans to really start working with the top line revenue piece and really retain those Varian customers and make them Agilent customers where they are today. Nick?

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

[Operator Instructions] Your next question comes from the line of Ajit Pai with Thomas Weisel Partners.

A couple of quick questions. I think the first one is just looking at the operating margins. I think you’ve highlighted how the gross margins are close to records especially for a second quarter. But on the operating margin side, even on sort of depressed revenues, you’ve seen some of the best margins you have ever seen for a second quarter. Can you give us some color as to whether all the sort of expense cutbacks that you are rolling back on variable comps some of the other expense controls? Have you loosened them and is the full impact of losing them already in the April quarter or will we see the full impact of that in the July and October quarters?

As we react to the downturn of 2009, we took $525 million of fixed costs out of the system, an additional $400 million of variable expense including 10% salary cut for most of the country. As we go through recovery, we have fully restored pay and we did that on November 1. And secondly, as Didier had outlined, the variable pay that we saved is going to come back rapidly. It is all self-consistent with the Agilent variable pay system, which is targeted at 10% at a 21% Return On Invested Capital. It will be the pay for the results for the management team as the recovery happens. And also, with the order rate coming in so much higher than revenue, our sales compensation is higher than what you would expect. One thing that we have done though that will moderate the second half variable spending is that we have reset the results for the management team in the second half of the year. Obviously, the pay in the first half of the year is well over target. It's always hard to predict the future when you're going through a downturn. And so as a result of that we are resetting the bar for the leadership team starting with myself in the second half, which will take away some of the upward pressure that we're seeing in the variable spending as the recovery comes about.

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

So is that fair to say then if you're actually controlling the increase in success-based compensation that the current record levels of operating margin for the second quarter are experienced, not including the downward pressure to have enough margins in the near-term, that you should actually be seen to set records in op margins excluding Varian?

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

And when you run the model, you will see that based on the projections that the guidance will give you, yes indeed, we're expecting an increase in our running profit in the semester in H2 versus H1. So we have not reached the high of our earning profits.

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

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

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

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

You have a follow-up question from the line of William Stein with Credit Suisse. William Stein - Crédit Suisse: Bill, we haven't really talked a lot about Europe. In particular, the recent macroeconomic concerns there and the weaker Euro. Can you give us a brief comment on how you expect that to impact your business?

I'm not sure that I have any better crystal ball than anyone else. Our revenue is up 10%. Unfortunately, it was down sequentially. There are concerns in Europe. Right now, Europe is about 24% of our business. So again, it's the smallest segment from a geography versus the other regions. But we had, had the exact same concerns as anyone, that slower growth in revenue would have an impact. In the short-term, we've got some easy comparers. We have a very credible product portfolio, people are investing moving forward, but we would have the same concerns as anyone else. William Stein - Crédit Suisse: So that contemplating this, I guess what’s gone on recently there, made it into guidance, I assume?

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

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

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

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

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