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Agilent Technologies’ (A - Analyst Report) fiscal third-quarter earnings per share of 68 cents beat the Zacks Consensus Estimate by 6 cents, or 9.6%.

Revenue

Agilent’s revenue of 1.65 billion was down 4.6% sequentially and 4.1% year over year.

The Asia/Pacific remained the biggest contributor to revenues with a 39% share. The Americas was next with 35%, followed by Europe, which accounted for the balance. While all three regions declined sequentially, it was most pronounced in the Americas (down 5.6%), followed by the Asia/Pacific, which declined 4.9% and Europe, which declined 2.8%. The Americas dropped 14.3% from the year-ago quarter, with the Asia/Pacific coming in flattish and Europe up 6.0%.

The most significant declines were in the aerospace/defense and communications markets with pharma/biotech and petro/chemical testing being the only end markets to have seen sequential growth. However, food and aerospace/defense also grew from last year.

Revenue by Segment

Agilent reports results under four segments—Chemical Analysis, Life Sciences, Electronic Measurement and Diagnostics & Genomics.

In the last quarter, Agilent’s Electronic Measurement segment remained the largest contributor, accounting for 42% of its revenue. The segment was down 7.8% sequentially and 17.0% year over year indicating continued softness in key areas.

The significant weakness in the last quarter was on account of the loss of a major handset manufacturing test customer. Still-modest capacity additions and over capacity conditions (in some cases) in the semiconductor equipment market, the secular decline in the PC market and the negative macro impact on the industrial market are the main reasons for this softness.

Agilent’s Life Sciences segment generated 24% of revenues, which was down 1.0% sequentially and up 2.6% year over year. This sequential decline was attributable to the residual negative impact of government spending decisions, which has impacted the academia and government business. Management said that stronger consumables, services, support and informatics sales resulted in the year-over-year increase.

Technology upgrades on the pharma side remained a positive for both the sequential and year-on-year comparisons. Additionally, LC/LCMS product introductions continued.

The Chemical Analysis segment generated 23% of revenue, which was down 3.5% sequentially and up 1.6% from the year-ago quarter. Despite the lower government spending that impacted the environmental and forensics business for yet another quarter, Agilent saw continued strength in chemical, energy and food testing segments across several emerging markets (particularly China).

The recently-added Diagnostics and Genomics segment accounted for 10% of revenue in the last quarter, down 1.8% sequentially. The core business (excluding Dako) was up 6% year over year. Segment revenue stayed 53.8% above the year-ago level. New product launches and expansion in Asia continue but market growth rates remain sluggish, which is a dampener.

Orders

Agilent’s orders were down 5.2% sequentially and 3.7% from the year-ago quarter. The most significant sequential decline was in Life Sciences, although it was still above the year-ago period. Chemical Analysis orders were down 4.4% sequentially but up 4.8% from the year-ago quarter.

Electronic Measurement remained a disappointment, with orders shrinking 3.9% and 16.9%, respectively, from the previous and year-ago quarters. Diagnostics and Genomics orders dropped 5.2% sequentially, staying 50.9% over the year-ago level.

Margins

The pro forma gross margin for the quarter was 54.3%, down 49 basis points (bps) sequentially and up 61 bps from the year-ago quarter. The sequential contraction was related to volume declines in the Electronics Measurement segment and unfavorable mix in the Diagnostics and Genomics segment. The strength in the new Diagnostics segment remains a positive for the overall gross margin, since the segment generates significantly higher gross margins than the legacy Agilent business.

Operating expenses dropped 3.4% sequentially while increasing 3.3% from the year-ago quarter. However, the operating margin shrank 94 bps sequentially and 197 bps year over year to 18.3%, as all expenses increased as a percentage of sales.

The Electronic Measurement operating margin shrank 212 bps sequentially and shrank 491 bps year over year. The Life Sciences margin expanded 165 bps sequentially and 213 bps from the year-ago quarter. The Chemical Analysis margin shrank 75 bps sequentially while expanding 45 bps from last year. The Diagnostics and Genomics margin shrank 214 bps and 37 bps from the year-ago quarter.

Net Income

Agilent generated a pro-forma net income of $233 million or 14.1% net income margin compared to $269 million or 15.5% in the previous quarter and $278 million or 16.1% in the year-ago quarter. Our pro-forma estimate excludes acquisition-related costs, restructuring charges, amortization of intangibles and other one-time items, as well as tax adjustments.

Including these items, the GAAP net income was $168 million ($0.49 per share) compared with income of $166 million ($0.48 cents per share) in the previous quarter and $243 million ($0.69 cents per share) in the year-ago quarter.

Balance Sheet

Inventories were up 1.2% sequentially to $1.05 billion with turns down slightly from 3.0X to 2.9X. The company ended with cash and cash equivalents of $2.33 billion, down $189 million during the quarter. Agilent’s long-term debt was $2.70 billion at quarter-end.

Cash generated from operations was $215 million compared to $315 million generated in the second quarter. Important uses of cash during the quarter included $53 million on capex, $41 million on dividends, $681 million on share repurchases and $250 million for the repayment of senior notes.

Guidance

Agilent provided guidance for the fourth quarter of 2013 and updated the guidance for the year.

In the fourth quarter, Agilent expects revenue of $1.70 billion to $1.72 billion and non-GAAP earnings of 75 to 77 cents a share. Analysts polled by Zacks were expecting earnings of 76 cents, within the guidance.

For fiscal year 2013, Agilent expects revenue of between $6.76 billion and $6.78 billion (previous $6.75 and $6.85 billion). Non-GAAP earnings are expected to be $2.83 to $2.85 a share (previous $2.70 to $2.85).

Recommendation

Agilent’s results were better than expected although the persistent weakness in several end markets because of government sequestration in the U.S., macro weakness in the U.S. and Europe, sluggish semi capex spending, secular decline in PCs and the loss of a major wireless customer remain negatives.

Agilent’s 2013 guidance indicates that the persistent weakness will be offset by cost efficiencies. Earlier the company announced a restructuring initiative that would, after completion, result in a reduction of its workforce by 450 and generate cost savings in the neighborhood of $50 million a year.

While the current outlook for this Zacks Rank #3 (Hold) stock is negative, we remain positive about Agilent’s broader portfolio and diversification into segments with higher growth potential. Further, it continues to introduce new products (with higher margins), which along with those acquired from Dako and Varian have greatly improved its margin profile.

We note that peers Teradyne (TER - Analyst Report) and Ametek Inc (AME - Snapshot Report) also have a Zacks Rank #3, reflecting the difficult market conditions. However, National Instruments Corp (NATI) carries a Zacks Rank #2 (Buy) indicating that this stock would be a safer bet for investors looking for exposure to the segment.

We continue to expect that Agilent, which remains one of the largest providers of spectrum analyzers, network analyzers, signal sources and oscilloscopes to government and research organizations, will see a quick turnaround once market conditions improve.

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