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Agilent Technologies’ (A - Analyst Report) fiscal second-quarter earnings per share of 77 cents beat the Zacks Consensus Estimate by 10 cents, or 6.7%.

Revenue

Agilent’s revenue of 1.73 billion was up 3.1% sequentially and flat year over year, just short of the Zacks Consensus Estimate of 1.74 billion.

The Americas remained the biggest contributor to revenues with a 36% share. The Asia/Pacific was next with 39%, followed by Europe, which accounted for the balance. While the Americas and Europe grew 4.9% and 9.0% on a sequential basis, Europe declined 7.1%. However, Europe was up 8.6% from last year, the only region to have posted year-over-year growth.

Overall, government spending patterns and policies are impacting Agilent’s revenues in both the U.S. and Europe and not all of this can be tracked to a specific market. Industrials, defense, environmental/forensics, academia are some of the areas seeing the impact. The fact that Japanese government initiatives have not kicked in yet also paint a gloomy picture.

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 44% of its revenue. However, while the 5.3% sequential increase was encouraging, the 13.2% year-over-year decline indicates continued softness in key areas.

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. Handset manufacturing test was also weak, as Agilent lost a big customer account, with wireless R&D also declining slightly. Strong overseas sales offset weak domestic sales in the aerospace/defense market.

Agilent’s Life Sciences segment generated 23% of revenues, which was up 1.0% sequentially and 2.5% year over year. This segment suffered the brunt of government spending decisions, with U.S. sequestration having a significant impact on the academia and government business. Technology upgrades on the pharma side remained a positive for both the sequential and year-on-year comparisons. The LC/LCMS lines and recurring revenue remained strong.

The Chemical Analysis segment generated 23% of revenue, which was up 1.8% sequentially and 3.4% from the year-ago quarter. Despite the lower government spending that impacted the environmental and forensics business, 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, up 1.8% sequentially. The core business (excluding Dako) was up 38% year over year. Expanding partnerships are driving growth for the segment. New product launches and expansion in Asia are also helping.

Orders

Agilent’s orders were down 1.3% sequentially and 8.3% from the year-ago quarter. Electronic Measurement remained a disappointment, with orders shrinking 6.4% and 26.8%, respectively, from the previous and year-ago quarters. Diagnostics and Genomics orders were up 147.0% year over year (due to the addition of Dako), but were down slightly on a sequential basis.

The Life Sciences and Chemical Analysis segments saw business improving. These two segments grew 4.8% and 2.3%, respectively on a sequential basis and 1.5% and 0.0%, respectively from last year. Life Sciences and Chemical Analysis segments built some backlog, while the other two segments depleted.

Margins

The pro forma gross margin for the quarter was 54.8%, down 15 basis points (bps) sequentially and up 67 bps from the year-ago quarter. The sequential increase was volume-related. Additionally, the high-margin EM business saw the most significant increase, so there was a mix factor as well. 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 3.1% sequentially while increasing 2.3% from the year-ago quarter. Therefore, the operating margin expanded 214 bps sequentially while shrinking 16 bps year over year to 19.3%, as all expenses increased as a percentage of sales.

The Electronic Measurement operating margin expanded 321 bps sequentially and shrank 288 bps year over year. The Life Sciences margin shrank 15 bps sequentially while expanding 392 bps from the year-ago quarter. The Chemical Analysis margin expanded 164 bps sequentially and 338 bps from last year. The Diagnostics and Genomics margin expanded 398 bps and shrank 340 bps from the year-ago quarter.

Net Income

Agilent generated a pro-forma net income of $269 million or 15.5% net income margin compared to $222 million or 13.2% in the previous quarter and $275 million or 15.9% 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 $166 million ($0.48 per share) compared with income of $179 million ($0.51 cents per share) in the previous quarter and $255 million ($0.72 cents per share) in the year-ago quarter.

Balance Sheet

Inventories were flat sequentially and stayed at $1.04 billion with turns up slightly from 2.9X to 3.0X. The company ended with cash and cash equivalents of $2.52 billion, up $69 million during the quarter. Agilent’s long-term debt was $2.11 billion at quarter-end.

Cash generated from operations was $315 million compared to $245 million in generated in the first quarter. Important uses of cash during the quarter included $51 million on capex, $41 million on dividends and $140 million on share repurchases.

Guidance

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

In the second quarter, Agilent expects revenue of $1.63 billion to $1.66 billion and non-GAAP earnings of 60 to 64 cents a share. Analysts polled by Zacks were expecting earnings of 75 cents, much lower than the guidance.

For fiscal year 2013, Agilent expects revenue of between $6.75 billion and $6.85 billion (previous $6.9 and $7.1 billion). Non-GAAP earnings are expected to be $2.70 to $2.85 a share (previous $2.70 to $3.00).

Recommendation

While Agilent reported a strong second quarter and share prices also responded positively, management cautioned against 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.

The persistent weakness is going to result in weaker margins and thereby, earnings for Agilent, which is reflected in its lowered 2013 guidance. On the positive side, a restructuring initiative was announced 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 - Analyst Report) also have a Zacks Rank #3, while National Instruments Corp (NATI - Snapshot Report) carries a Zacks Rank #4, reflecting the difficult market conditions. Therefore, Agilent, which remains one of the largest providers of spectrum analyzers, network analyzers, signal sources and oscilloscopes to government and research organizations, should see a quick turnaround once market conditions improve.

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