Agilent Hit by Weakening Demand

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Agilent Technologies’ (A) fiscal third quarter earnings missed the Zacks Consensus by 4 cents (4.8%). Revenue was also short of our expectations, missing by 3.7%.

Revenue

Agilent’s revenue was flat sequentially and up 1.9% year over year, short of management’s expectations of a 2-3% sequential increase($1.77 billion to $1.79 billion). Management attributed the decline to weakness in the manufacturing sector all over the world, which resulted in order push-outs into the fiscal fourth quarter. Currency and acquisitions taken together were neutral to the comparison with the year-ago quarter.

The Asia/Pacific was notably weak in the last quarter, declining 10.3% and 4.7% from the previous and year-ago quarters, respectively. Growth in China is slowing down, which impacted Agilent in the last quarter and has the potential to continue impacting revenue through the rest of 2012.

Management indicated that some of the decline was also attributable to more orders pertaining to Asia being taken outside the region, as a result of which the related revenue was also being booked outside. The sequential and year-over-year declines of 0.6% and 1.7%, respectively in Europe were less than in the April quarter, although spending remains weak due to economic pressures.

The Americas did rather well all things considered, with revenues growing 10.5% sequentially and 11.2% from last year. The Americas, Asia and Europe generated 40%, 37% and 23%, of quarterly revenue, respectively.

Revenue by Segment

Agilent has been reporting results in three segments—Chemical Analysis, Life Sciences and Electronic Measurement. However, after it closed the Dako acquisition in the last quarter, it now has a fourth segment, which has been named Diagnostics and Genomics.

Agilent’s Electronic Measurement segment remains its largest, with a revenue contribution of 49% in the last quarter. The weakness was on the computing/semiconductor sides of the business. Communications was very strong, driven by wireless testing activity, although it was partially offset by weakness on the optical side of the business and a softer infrastructure market overall.

The industrial business was impacted by macro concerns all over the world and declining spending levels. Computing was also soft, in line with broader market trends. Additionally, the aerospace/defense business remains sluggish, impacted by lower business from defense contractors in the last quarter.

Relatively stable U.S. government spending was offset by weakness at defense contractors in the last quarter. Agilent remains one of the largest providers of spectrum analyzers, network analyzers, signal sources and oscilloscopes into these markets, so its market position is a positive for the longer term. Segment revenue is very well diversified across geographies, with only Europe contributing a smaller percentage (a positive in the current environment).

The Life Sciences segment generated 23% of revenue, down 1.0% sequentially and up 2.1% from last year. The academic/government market remained weak compared to the year-ago quarter and was joined by the pharma/biotech segment in the last quarter. Pharma/biotech was particularly weak relative to the previous quarter, offsetting the flat revenues in academic/government.

The Chemical Analysis segment generated 22% of third quarter revenue, down 8.8% sequentially and 7.0% year over year. The sequential decline was largely on account of weakness in food testing, although chemical/energy was also down significantly and the forensics/environmental was flattish. All three markets fared similarly when compared with the year-ago quarter.

The newly added Diagnostics and Genomics segment accounted for 6% of revenue in the last quarter.

Orders

Agilent saw orders declining 9.7% sequentially and 1.5% year over year. Electronic Measurement, being the largest segment by far had the most significant impact (down 15.3% sequentially, 3.7% year over year). Life Sciences orders were down 9.0% sequentially and 2.4% from year-ago levels.

The Chemical Analysis segment saw orders dropping 8.8% sequentially and 7.0% from a year ago. Diagnostics and Genomics accounted for 6% of revenue.

Agilent’s book-to-bill ratio rose above unity, as BTB was positive across all segments.

Margins

The proforma gross margin for the quarter was 53.7%, down 44 basis points (bps) sequentially and 72 bps from the year-ago quarter. The strength in the wireless manufacturing segment continued to drive up costs for Agilent, thus impacting the overall numbers.

Operating expenses dropped 4.3% sequentially and were flattish with the year-ago quarter, as Agilent continued cost-containment efforts. As a result of these efforts, the operating margin, at 20.3%, expanded 87 bps sequentially and 15 bps from last year. Both R&D and SG&A declined as a percentage of sales from the previous and year-ago quarters, although cost of sales increased.

The Electronic Measurement operating margin contracted 9 bps sequentially and 52 bps year over year. However, Life Sciences and Chemical Analysis expanded 344 bps and 218 bps, respectively from the previous quarter and 126 bps and 37 bps, respectively from the July quarter of 2011.

Net Income

Agilent generated a pro forma net income of $278 million, or a 16.1% net income margin compared to $275 million or 15.9% in the previous quarter and $275 million, or 16.3% in the third quarter of last year. Our pro forma estimate excludes acquisition-related costs, amortization of intangibles and other one-time items, as well as tax adjustments.

On a fully diluted GAAP basis, the company recorded a net income of $243 million ($0.69 per share) compared to income of $255 million ($0.72 per share) in the previous quarter and $330 million ($0.95 per share) in the year-ago quarter.

Balance Sheet

The balance sheet shows a net debt position of $291 million, compared to a net cash position of $1.72 billion at the beginning of the quarter. Agilent generated $240 million from operations in the last quarter, spending $49 million on capex, $2.2 billion on acquisitions and $35 million on dividends but did not repurchase any shares. The debt-to-total-capitalization ratio dropped slightly to 31.2% from 31.5% at the beginning of the quarter.

Inventories at quarter-end were up 9.4% from the previous quarter, with annualized inventory turns down from  3.4X to 3.1X. Days sales outstanding (DSOs) went from 48 to around 50.

Guidance

Agilent expects fiscal fourth quarter revenue of $1.76 billion to $1.78 billion (a 2-3% sequential increase). Consensus expectations were at $1.87 billion when the company announced guidance, above the guided range. Non-GAAP earnings are expected to be 80 to 82 cents a share, much softer than the Zacks Consensus Estimate of 93 cents (at the mid-point).

Agilent expects 2012 core revenue growth of around 3% at current exchange rates, with the non-GAAP earnings coming in the range of $3.07 a share (previous $3.18 to $3.24 a share). The weak guidance was on account of a softer demand environment.

Recommendation

Agilent’s results are reflective of the same factors that have hit other test equipment providers, such as Teradyne (TER) and Advantest Corp (ATE). Agilent’s broader portfolio and diversification into segments with better growth potential make us more positive about the company.  

In recent times, Agilent’s focus has shifted to life sciences, genomics, diagnostics and wireless test markets, where the company has made a few important acquisitions (Varian and more recently Dako). The company already enjoys a strong position in its served markets and its attempt to strengthen its position in these segments is sound strategy.

Agilent also continues to introduce new products (with higher margins), which along with those acquired from Varian should generate continued growth. Cost control has also been commendable.

Despite these positives, we think that macro conditions will continue to weigh on the shares. We therefore have a short-term Hold rating on Agilent shares, as indicated by the Zacks #3 Rank.

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