Agilent Technologies’ (A) third-quarter earnings beat the Zacks Consensus Estimate by 6 cents, or 12.5%. Revenues of $1.38 billion exceeded by 2.3%.
Operating and net margins were up again on a sequential basis, although the gross margin decreased. However, all margins grew comfortably from the year-ago quarter.
Operating and net margins were up again on a sequential basis, although the gross margin decreased. However, all margins grew comfortably from the year-ago quarter.
Revenue
Agilent’s revenues grew 8.9% sequentially and 30.9% year over year. Varian contributed $135 million, or 9.8%, of quarterly revenue (net of fair value adjustments), excluding which revenues would have declined 1.7% sequentially and increased 18.2% year over year. Organic revenue growth was fueled by improving demand across all geographic regions, although the Asia/Pacific region witnessed the strongest growth at 28%, followed by the Americas, which grew 25%, and Europe, which grew 18%. The strongest markets in Asia were India and China, which increased 43% and 24%, respectively.
Revenues by Segment and Product Line
Management changed the reporting structure from the first quarter of 2010. Agilent is now reporting results in three segments — Chemical Analysis, Life Sciences and Electronic Measurement.
The Chemical Analysis (“CA”) segment generated 24% of third quarter revenue, with double-digit year-over-year growth in petrochemicals, environmental and forensic markets. Excluding the impact of the Varian acquisition, revenues were up 13% from the year-ago quarter. The food safety market remains strong, although growth rates were not as high as in past quarters. Segment revenue was up 38.2% sequentially and 62.1% from a year ago. High-end mass spectrometry, the GC triple quad line, vacuum products and consumables witnessed strong demand.
The Life Sciences (“LS”) segment generated 27% of total revenue, up 12.0% sequentially and 27.6% from the year-ago quarter. Excluding Hycor and Varian, segment revenue was up 15% year over year. The government, academic and pharmaceutical R&D markets drove the increase in the last quarter. Excluding the impact of Hycor and Varian, revenue from government and academic markets were up 21% year over year, while revenue from the pharma/biotech market was up 6%. Liquid chromatography platforms remained the major driver of segment revenue, growing 25% from the year-ago quarter. The LCMS line also grew. The recently launched SureSelect sample preparation category continued to beat management expectations.
The Electronic Measurement (“EM”) segment generated 50% of quarterly revenue, declining 1.0% sequentially and increasing 23.4% from the year-ago quarter. The networking solutions business, which the company has since disposed of, contributed to revenue in the year-ago quarter, so excluding such contribution, segment revenue was up 34%. The increase from the year-ago quarter was driven by broad-based strength across the communications, aerospace and defense, industrial and semiconductor markets. The strength in industrial was due to the recovery in China. The aerospace and defense market, which grew 24%, benefited from increased spending both in the U.S. and in Asia. The communications test business was driven by LTE and smartphones, as well as 3G rollouts in Asia. Management stated that the wireless research and development business continued to outgrow wireless manufacturing, which is typically a more volatile business. Network analyzers and high-end oscilloscopes were particularly strong in the last quarter with network analyzers growing 58% and oscilloscopes growing 45%. Agilent remains one of the largest providers of network analyzers and spectrum analyzers in the world.
Orders
Orders were up strongly in the last quarter, growing double digits on both sequential and year-over-year bases. The CA business witnessed the strongest growth, increasing 51.5% sequentially and 70.7% year over year. This was followed by the LS business, which grew 18.1% sequentially and 35.8% year over year. The EM business saw some slowdown, with segment revenues declining 4.3% sequentially, although they continued to increase on a year-over-year basis. All segments had book-to-bill well over 1 and accumulated backlog in the last quarter.
Margins
Margins in the last quarter benefited from higher volumes, the Varian contribution and cost reductions from restructuring actions.
The pro forma gross margin for the quarter was 56.0%, down 89 basis points (bps) sequentially and up 273 bps from the year-ago quarter. The EM segment gross margin was the strongest at 59%, followed by LS at 54% and CA at 53%.
The operating expenses of $524 million were up less than 1% sequentially, but nearly 9% year over year. The operating margin was 18.1%, up 209 bps sequentially and 1,047 bps from the year-ago quarter.
The sequential increase in operating margin was largely on account of the EM segment, which saw sequential and year-over-year margin expansion of 405 bps and 2,031 bps, respectively. The operating margin in the LS segment was up 60 bps sequentially and 166 bps from a year ago. The operating margin in the CA segment was disappointing. The segment saw margin declines of 298 bps and 464 bps from the previous and year-ago quarters.
Net Income
Agilent generated pro forma net income of $191 million, or a 13.8% net income margin compared with $151 million or 11.9% in the previous quarter and $53 million, or 5.0% in the third quarter of last year. Our pro forma estimate exclude restructuring charges, amortization of intangibles, impairment of long-lived assets and other one-time items on a tax adjusted basis.
On a fully diluted GAAP basis, the company recorded net income of $205 million ($0.58 per share) compared with income of $108 million ($0.31 per share) in the previous quarter and a net loss of $19 million ($0.06 per share) in the year-ago quarter.
Balance Sheet
The balance sheet shows a net debt position of $1.36 billion. The debt to total capitalization ratio was 56.7%, which is on the high side. The interest coverage ratio is 10.5X, which means the company should not have trouble servicing the debt. Agilent raised $750 million last month to pay off the debt due in January 2011. Although this will require the company to incur additional debt of $5 million over the next two quarters, the quarterly saving in interest payment will be $7 million thereafter.
Inventories at quarter-end were up 26.0%, with annualized inventory turns going down around 4.0x to 3.5x. The increase in inventory was partially attributable to Varian inventory taken over. Days sales outstanding went up again in the last quarter to around 52, compared with 48 at the end of the second quarter. Agilent generated around $90 million of cash from operations, spent $1.3 billion on acquisitions, $33 million on capex and $94 million on share repurchases. The company received $196 million from business divestitures.
Guidance
Management expects fourth quarter revenue of around $1.52 billion, representing a sequential increase of 9.8% and a year-over-year increase of 30.2%. Organic revenue is expected to grow 21%. The non GAAP EPS for the quarter is expected to come in at around 58 to 59 cents. The reasons for the soft earnings outlook are increased expenses related to Varian, higher sales commission, higher interest expenses and higher taxes.
For fiscal 2010, Agilent expects revenue of $5.4 billion, with the organic EPS at $1.94 to $1.95 (previous $1.78 to $1.83) and adjusted for the divestitures to be up 12% to 15%, with the non GAAP EPS coming in at $1.70 to $1.75. Previous guidance was for revenue growth of 10% and earnings per share of $1.65–$1.70 in fiscal 2010.
Varian is expected to add $370 million to annual revenue and 8 cents to the EPS. Management estimates that approximately 70% of the business will be reported under the Chemical Analysis segment, with the balance going to Life Sciences.
Our Take
We believe Agilent shares will benefit from a strengthening domestic market as well as a growing opportunity pipeline abroad, especially in Asian countries, such as China and India. Agilent has a very well-diversified business and has prudently supplemented organic growth with acquisitions. However, we note that the company saw component shortages in the last quarter that impacted all three segments. The shortage is expected to continue in the next quarter as well. Additionally, the semiconductor testing business could see some slowdown. We have a short term Zacks #4 Rank (‘sell’) on Agilent shares, since we believe there could be some near-term pressure on prices. Our longer-term recommendation is Neutral.
