Agilent Technologies Inc. (A) beat the second quarter Zacks Consensus earnings per share by a penny, or 2.4%. Revenue of $1.27 billion beat by 2.5%. Shares were buoyant during the day, but dropped off 2.02% after-hours.
 
Agilent saw another quarter of expansion in gross, operating and net margins. However, investors probably expected stronger earnings, since the positive surprise percentage averaged at around 20.7% in the preceding four quarters.
 
Revenue
 
Agilent’s revenue grew 4.8% sequentially and 16.5% year over year. The growth witnessed in the reported quarter was comparable to pre-recession rates. Revenue was fueled by improving demand across all geographies, with Asia witnessing the strongest growth at 26% (24% when adjusted for currency), followed by the Americas, which grew 13% (11% when adjusted for currency) and then Europe, which grew 10% (6% when adjusted for currency).
 
Revenue by Segment and Product Line
 
Management has changed the reporting structure beginning in 2010. Agilent is now reporting results in three segments — Chemical Analysis, Life Sciences and Electronic Measurement.
 
The Chemical Analysis segment generated 19% of second quarter 2010 revenue, helped by a 30%+ growth in petrochemicals, more than 15% growth in food, and over 27% growth in environment and forensics markets. Segment revenue was up 19% from a year ago, although it was down 2.5% sequentially due to seasonality. The consumables business was the strongest, increasing 21%, while services grew 11%. The platform (GC/MS and ICP/MS instrumentation) also grew double digits.
 
The Life Sciences segment generated 26% of revenue, up 12.1% from the year-ago quarter and down 1.8% sequentially. The year-over-year revenue grew in spite of the divestiture of the Hycor business, which contributed to year-ago results. Pharma and biotech were softer in the reported quarter, and even after excluding the Hycor contribution from the year-ago quarter, revenues increased by a mere 4%. However, academic and government revenues were stronger, growing 11%. Liquid chromatography platforms reported higher-than-expected revenues, increasing 28%, driven by improving conditions all over the world. The LCMS line also saw a revenue spike. Additionally, Agilent saw the consumables business picking up, with double-digit growth in the recently launched SureSelect sample preparation category.
 
The real turnaround in Agilent’s second quarter 2010 was the Electronic Measurement segment, which generated 55% of quarterly revenue, the highest level in six quarters. The 17.9% increase from the year-ago quarter was fueled by the resurgent general purpose product line, which saw particular strength in industrial, computing and semiconductor markets, together growing 56%. However, this was partially offset by the continued weakness in aerospace and defense, particularly in the U.S. The communications test line was impacted by weak spending on wireless research and development (R&D), which offset increases in other areas. Although spending on handset test capacity remained weak, smart phones drove some increases in the reported quarter. Segment revenue was up 11.1% sequentially. Agilent remains one of the largest providers of network analyzers and spectrum analyzers, which continued to grow in the second quarter 2010. The company’s high performance oscilloscopes witnessed particularly strong demand from the computing and semiconductor markets.
 
Orders
 
Orders were up very strongly in the reported quarter, growing double digits on both sequential and year-over-year bases. The strength was driven by the Electronic Measurement segment, which saw sequential and year-over-year increases of 22.1% and 43.9%, respectively. Although both the Chemical Analysis and Life Sciences segments grew from the year-ago quarter, they were down on a sequential basis.
 
The Electronic Measurement segment was the only one to record a positive book-to-bill ratio, indicating that the other two segments experienced lower turns. However, the strength in Electronic Measurement ensured a net addition to backlog in the quarter.
 
Margins
 
Margins in the second quarter 2010 benefited from higher volumes and cost reductions from restructuring actions, partially offset by wage reinstatements.
 
The pro forma gross margin in the quarter was 56.9%, up 82 basis points (bps) sequentially and 482 bps year over year. The operating expenses of $519 million were flat sequentially.
 
The operating margin was 16.1%, up 113 bps sequentially and 991 bps year over year. The sequential increase was mainly due to lower cost of goods sold and R&D (as a percentage of sales), partially offset by the slightly higher selling, general and administrative expenses (as a percentage of sales).
 
The sequential increase in operating margin was entirely on account of the Electronic Measurement segment, which saw a margin expansion of as much as 509 bps. The increase from the year-ago quarter was also driven by the whopping 1,802 bps increase in Electronic Measurement, although this was also helped by a 145 bps increase in Chemical Analysis and partially offset by a 39 bps decline in Life Sciences.
 
Net Income
 
Agilent generated pro forma net income of $151 million, or an 11.9% net income margin, compared with $135 million, or 11.1% in the previous quarter and $44 million, or 4.0% in the second quarter of last year. The pro forma estimate excludes 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 a net income of $108 million ($0.31 per share) compared with an income of $79 million ($0.22 per share) in the previous quarter and a net loss of $101 million ($0.29 per share) in the year-ago quarter.
 
Balance Sheet
 
The balance sheet shows a net debt position of $237 million. The debt-to-total capitalization ratio was 52.4%, which is not bad. The interest coverage ratio is 9.3X, which means the company should not have trouble servicing the debt. Management stated that Moody’s recently upgraded the company’s debt rating to BAA3, which means that the company’s debt may now be considered investment grade.
 
Inventories at quarter end were down 0.4%, with annualized inventory turns increasing slightly from around 3.9X to 4.0X. Days sales outstanding (DSOs) inched up from around 47 to roughly 48. Agilent generated around $224 million of cash from operations, spent $29 million on capex and $165 million on share repurchases. The company received $20 million from business divestitures.
 
Guidance
 
Management expects third quarter revenue (excluding the recently-acquired Varian) to increase 16% to 19% from the third quarter of fiscal 2009, or 22% to 25% when adjusted for the network systems and Hycor business divestitures. The non-GAAP EPS for the quarter is expected to come in at around 43 to 45 cents.
 
For fiscal 2010, Agilent expects standalone revenues (excluding Varian) and adjusted for the divestitures to be up 12% to 15%, with the non-GAAP EPS coming in at $1.70 to $1.75. The previous guidance was for revenue growth of 10% and earnings per share of $1.65-1.70 for fiscal 2010.
 
Varian is expected to add $370 million to annual revenue and 8 cents to EPS. Management estimates that approximately 70% of the business will be reported under the Chemical Analysis segment, with the balance going to Life Sciences.
 
Rating Reiterated
 
We believe Agilent shares will benefit from a strengthening domestic market as well as a growing pipeline opportunity abroad, especially in Asian countries such as China. The company has a very well-diversified business and has prudently supplemented organic growth through acquisitions.
 
We are extremely positive about the company’s growth prospects over the next three to six months. Consequently, we reiterate our Outperform recommendation on Agilent shares.
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