Exhibit 99.1

 

Item 1.       Business

 

Overview

 

Agilent Technologies, Inc. (“we”, “Agilent” or the “company”), incorporated in Delaware in May 1999, is the world’s premier measurement company providing core bio-analytical and electronic measurement solutions to the communications, electronics, life sciences and chemical analysis industries.

 

In August 2005, the Board of Directors of Agilent approved the divestiture of both our semiconductor products business and our semiconductor test solutions business. Both of these divestitures were completed during our most recent fiscal year. In December 2005, we completed the sale of our semiconductor products business to Avago Technologies Ltd. (“Avago”) for approximately $2.6 billion in cash proceeds. On June 1, 2006, Agilent transferred substantially all of the assets and liabilities of its semiconductor test solutions business to a separate company, Verigy Ltd. (“Verigy”), then a wholly owned subsidiary of Agilent. In June and July 2006, Verigy sold approximately 8.7 million of its ordinary shares, or approximately 15 percent of its outstanding shares, in an initial public offering. On October 31, 2006, we distributed our remaining holding in Verigy to our stockholders.

 

We have reflected the semiconductor products business and the semiconductor test solutions business as discontinued operations for all periods presented in this Current Report on Form 8-K. For further information, see Note 3, “Discontinued Operations of Our Semiconductor Products Business” and Note 4, “Discontinued Operations of Our Semiconductor Test Solutions Business”, to our consolidated financial statements.

 

We currently have two businesses, the electronic measurement business and the bio-analytical measurement business. Our electronic measurement business focuses on growth opportunities in the communications and electronics industries, while our bio-analytical measurement business focuses on core business and growth opportunities in the life sciences industry and in the environmental, chemical, food and petrochemical industries. In addition to our two businesses, we conduct centralized research through Agilent Technologies Laboratories. Each of our businesses, including Agilent Labs, is supported by our general infrastructure organization, which provides shared services in the areas of finance, information technology, legal, workplace services and human resources.

 

We sell our products primarily through direct sales, but we also utilize distributors, resellers, manufacturer’s representatives, telesales and electronic commerce. Of our total net revenue of $4.97 billion for the fiscal year ended October 31, 2006, we generated 34 percent in the United States and 66 percent outside the U.S. As of October 31, 2006, we employed approximately 18,700 people worldwide. Our primary research, development and manufacturing sites are in California, Colorado, Delaware and Washington in the U.S. and in China, Germany, Japan, Malaysia, Singapore and the United Kingdom.

 

In the beginning of the third quarter of 2007, we moved the nanotechnology measurement from the electronics measurement segment to more closely align with the new materials sciences business in the bio-analytical measurement segment. All segment disclosures and numbers have been restated historically.

 

Net revenue for each of our businesses for the years ended October 31, 2006, 2005 and 2004 was:

 

		2006			2005			2004
		(in millions)
Electronic Measurement		$	3,302		$	3,168		$	3,121
Bio-analytical Measurement		1,671			1,518			1,437
Total Segment Revenue		$	4,973		$	4,686		$	4,558

 

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Electronic Measurement Business

 

Our electronic measurement business provides standard and customized electronic measurement instruments and systems, monitoring, management and optimization tools for communications networks and services, software design tools and related services that are used in the design, development, manufacture, installation, deployment and operation of electronics equipment and communications networks and services. Related services include start-up assistance, instrument productivity and application services and instrument calibration and repair. We also offer customization, consulting and optimization services throughout the customer’s product lifecycle.

 

Our electronic measurement business employed approximately 11,490 people as of October 31, 2006. We sell our electronic measurement products through direct sales, distributors, resellers, manufacturer’s representatives, telesales and electronic commerce. Our electronic measurement business generated $3.3 billion in revenue in fiscal 2006, $3.2 billion in revenue in fiscal 2005 and $3.1 billion in revenue in fiscal 2004.

 

Electronic Measurement Markets

 

Our electronic measurement products compete in the communications test market and the general purpose test market.

 

The Communications Test Market

 

We market our communications test products and services to handset manufacturers, network equipment manufacturers (“NEMs”) and communications service providers. NEMs manufacture and sell products to facilitate the transmission of voice, data and video traffic. The NEMs’ customers are the distributors of end-user subscriber devices, including wireless personal communication devices and set-top boxes, as well as communications service providers that deploy and operate the networks and services. To meet their customers’ demands, NEMs require test and measurement instruments, systems and solutions for the development, production and installation of each network technology.

 

Communications service providers require reliable network equipment that enables their networks and services to operate at ever-faster speeds, offer a growing range of services permits an expanding capacity and provides quick feedback. To achieve this, communications service providers require a range of sophisticated test instruments and systems to evaluate network performance and to identify any sources of communications failure.

 

Agilent’s communications service provider customers require advanced software and systems, known as operations support systems (“OSS”), to monitor and manage the network infrastructure and services on a continuous, proactive basis to achieve either regulated or customer-specified service levels.

 

The communications test market accounted for approximately 42 percent of revenue from our electronic measurement business in 2006.

 

The General Purpose Test Market

 

We market our general purpose test products and services to the electronics industry and other industries with significant electronic content such as the aerospace and defense industries. These electronics and electronics-dependent industries design, develop and manufacture a wide range of products, including those produced in high volumes, such as computers, computer peripherals, electronic components, consumer electronics, enterprise servers, storage networks and communications devices, and automotive electronics. The components, printed circuit assemblies and functional devices for these products may be designed, developed and manufactured by electronic components companies, by original equipment manufacturers or by contract manufacturers. For the development and timely commercialization of new technologies, manufacturers require state-of-the-art test instruments, systems and software design tools in order to design products for efficient and cost-effective manufacturing and to validate product performance in a variety of configurations and environments. They also demand automated functional test systems, which test an electronic device as if it were in use in its final environment.

 

Customers use our general purpose test solutions in development and manufacturing a wide variety of electronic components and systems. These include testing multiple parameters of printed circuit boards used in almost every electronic application; testing the electrical parameters of wafers used in the semiconductor manufacturing process; and testing of flat panel displays.

 

The general purpose test market accounted for approximately 58 percent of revenue from our electronic measurement business in 2006.

 

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Electronic Measurement Products

 

We divide our electronic measurement products into communications test products and general purpose test products.

 

Communications Test Products

 

We sell communications test products and services for the following types of communications networks and systems: fiber optics networks, transport networks, broadband and data networks, wireless communications and microwave networks. In addition, we provide assistance with installation and maintenance of our products and operational support systems to enable network, service and customer assurance for network operators.

 

Our suite of fiber optic network test products measure and analyze a wide variety of critical optical and electrical parameters in fiber optic networks and their comprising components.

 

Components which can be tested include source lasers, optical amplifiers, filters and other passive components.

 

Our broadband and data network test products include our network analyzer and router testers. Our network analyzer product line helps to troubleshoot high-speed local area networks, wide area networks and asynchronous transfer mode networks. Router testers are used to develop and test the performance of enterprise and carrier-class routers.

 

Our wireless communications and microwave network products include radio frequency and microwave test instruments and electronic design automation software tools, which assist in the design and production of cellular handsets and base stations, as well as satellite and aerospace defense systems.

 

Our installation and maintenance assistance facilitates the installation, commission and activation of networks and services. We have a breadth of products for troubleshooting and maintaining optical, wireless, wireline and large-company networks.

 

Our operational support systems products manage performance and quality of network service and customer experience for broadband, data, wireless and converged networks and services.

 

General Purpose Test Products

 

We sell the following types of products into the general purpose test market: general purpose instruments, modular instruments and test software, digital design products, parametric test products, high frequency electronic design tools, electronics manufacturing test equipment and thin-film transistor array test equipment, nano-positioning systems, atomic-force microscopy and scanning probe microscopy.

 

General purpose instruments are used principally by engineers in research and development laboratories, manufacturing, calibration and service for measuring voltage, current, frequency, signal pulse width and other standard electronics measurements and include spectrum analyzers, network analyzers, signal generators, digitizing oscilloscopes, voltmeters, multimeters, frequency counters, bench and system power supplies, function generators and waveform synthesizers.

 

Modular instruments and test software are used by the designers and manufacturers of electronic devices as the building blocks of systems that can be configured for a wide variety of test applications, and changed as needed by a combination of modular hardware and software components. Examples include test systems for aviation systems maintenance and multi-function university labs.

 

Our digital design products are used by research and development engineers in the computer, communications and semiconductor industries to validate and verify the performance of digital product designs. These include simple digital control circuits, complex high-speed servers, high-performance oscilloscopes, logic analyzers, logic-signal sources and data generators. Digital product design opportunities include high-speed input/output connectivity in computer servers and hardware development for latest generation gaming consoles.

 

Our high-frequency electronic design automation software tools are used by radio frequency integrated circuit design engineers to model, simulate and analyze communications product designs at the circuit and system levels. The main products in this area represent well-established software platforms within the wireless and the aerospace and defense design industries. Our customers are also applying this technology more frequently to model signal integrity problems in digital design applications.

 

Our parametric test instruments and systems combine hardware technology and customizable system software and are used primarily to examine semiconductor wafers during the semiconductor manufacturing process.

 

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Our electronic manufacturing test product categories are Automated Optical Inspection Products that enable automated visual inspection of printed circuit assemblies, Automated X-ray Inspection Products that provide a three-dimensional scan of printed circuit board assemblies to identify and isolate quality defects caused by the manufacturing process, Automated In-Circuit Testing Products that identify quality defects such as bad and incorrect parts that affect electrical performance and allow early repair of these defects, and Manufacturing Test System Software that provides common tools to enable customers to use information across the manufacturing line for effective process control, repair and test design.

 

Our thin-film transistor array tester products provide flat panel display (or FPD) manufacturers with test solutions in the rapidly growing FPD market. An array tester can provide significant cost savings by detecting defects early in the manufacturing process of FPDs.

 

Our nano-positioning products utilize very precise measurements (through laser interferometer technology) to ensure precise motion control and placement, used primarily in semiconductor manufacturing applications. Our products offer nanometer scale imaging and measurements in fluids, air and gases and are utilized in biotechnology, electrochemistry and materials science applications. The nano-positioning products were moved from the electronics measurement segment to the bio-analytical measurement segment in the beginning of the third quarter of 2007.

 

Electronic Measurement Customers

 

Agilent’s electronic measurement customers include contract manufactures, handset manufacturers, network equipment manufacturers who design, develop, manufacture and install network equipment, and service providers who implement, maintain and manage communication networks and services. We also engage in collaborative relationships with contract manufacturers. Many of our customers purchase solutions across several of our major product lines for their different business units. As of the end of fiscal 2006, no single customer represented greater than 10 percent of the net revenue of the business.

 

The orders and revenues from many of the electronic measurement markets and product categories are seasonal, with our fourth quarter traditionally bringing larger volumes of business and our first quarter generally showing reduced volumes. This is especially true of products that we sell in the aerospace and defense industry as well as those that are linked to consumer spending, including some of our communications test equipment. However, the seasonal impact is tempered by the diversity of the electronic measurement business’s products and customers, which span multiple industries.

 

Electronic Measurement Sales, Marketing and Support

 

We have a focused sales strategy, using a direct sales force, resellers, manufacturer’s representatives and distributors to strengthen customer satisfaction. Our direct sales force is focused on identifying customer needs and recommending solutions involving the effective use and deployment of our equipment, services, systems and capabilities. Some members of our direct sales force focus on global accounts, providing uniform services on a worldwide basis. Others focus on our more complex products such as our OSS communications monitoring and management systems, where customers require intensive strategic consultation. Our sales force also specifically targets the contract manufacturer market by collaborating with original equipment manufacturers to specify that contract manufacturers use our test equipment, as well as marketing to contract manufacturers directly.

 

Our direct sales force consists of field engineers and systems engineers who have in-depth knowledge of the customers’ business and technology needs. Our systems engineers provide a combination of consulting, systems integration and application and software engineering services and are instrumental in all stages of the sale, implementation and support of our complex systems and solutions.

 

To complement our direct sales force we have agreements with many channel partners around the world. These partners, including resellers, manufacturer’s representatives, and distributors, serve Agilent’s customers across a number of product lines and provide the same level of service and support expected from our direct channel. Lower volume transactions can also be served by our tele-sales and electronic commerce channels.

 

Our products typically come with standard warranties, and extended warranties are available for additional cost.

 

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Electronic Measurement Manufacturing

 

We concentrate our electronic measurement manufacturing efforts primarily on final assembly and test of our products. To maximize our productivity and our ability to respond to market conditions, we use contract manufacturers for the production of printed circuit boards, sheet metal fabrication, metal die-casting, plastic molding and standard electronic components. We also manufacture proprietary devices and assemblies, in our own fabrication facilities for competitive advantage.

 

We generally only manufacture products when we have received firm orders for delivery and do not generally hold large stocks of finished inventory.

 

Electronic Measurement Competition

 

The market for electronic measurement equipment is highly competitive. Our electronic measurement business competes with a number of significant competitors in all our major product categories and across our targeted industries. In the general purpose test market, we compete against companies such as Applied Komatsu Technologies, Fluke Corporation (a subsidiary of Danaher Corporation), Keithley Instruments, Inc., LeCroy Corporation, National Instruments Corporation, Photon Dynamics, Inc., Shimadzu Corporation, Tektronix, Inc., Teradyne, Inc., and Wintest Corp. In the communications test market our primary competitors are Aeroflex Incorporated, Anritsu Corporation, Ansoft Corporation, APLAC Solutions Corporation, Applied Wave Research, Inc., EXFO Electro-Optical Engineering, Inc., a unit of IBM Software (formerly Micromuse, Inc.), Ixia, JDS Uniphase, Marconi Corporation plc, Rohde & Schwartz GmbH & Co. KG, Spirent plc and Tektronix, Inc.

 

Our electronic measurement business offers a wide range of products, and these products compete primarily on the basis of product quality and functionality, as well as performance and reliability.

 

Bio-Analytical Measurement Business

 

Our bio-analytical measurement business provides application-focused solutions that include instruments, software, consumables and services that enable customers to identify, quantify and analyze the physical and biological properties of substances and products. Our seven key product categories include: microarrays, microfluidics, gas chromatography, liquid chromatography, mass spectrometry, software and informatics, and related consumables and services.

 

We employed approximately 4,460 people as of October 31, 2006 in our bio-analytical measurement business. This business generated revenue of $1.7 billion in fiscal 2006, $1.5 billion in fiscal 2005, and $1.4 billion in fiscal 2004.

 

Bio-Analytical Measurement Markets

 

Primarily, our bio-analytical measurement business serves the following markets:

 

Life Sciences Markets

 

Our life science markets accounted for approximately 40 percent of revenue from our bio-analytical measurement business in 2006. Within the life sciences, we focus on the following three primary market categories:

 

The Pharma, Biotech, CRO & CMO Market.    This market consists of “for-profit” companies who participate across the pharmaceutical value chain in the areas of: research, discovery & development, clinical trials, and manufacturing and quality assurance and quality control. One sub-segment of this market is the core and emerging pharmaceutical companies, or “Pharma”. A second sub-segment includes biotechnology companies, or “biotech”, contract research organizations, or “CROs”, and contract manufacturing organizations, or “CMOs”. Biotech and, to a somewhat lesser extent, CROs and CMOs typically participate in specific points in the Pharma industry value chain.

 

The Academic and Government Market.    This market consists primarily of “not-for-profit” organizations and includes academic institutions, large government institutes and privately funded organizations. The academic and government market plays an influential role in technology adoption and therapeutic developments for Pharma and molecular diagnostics companies. After decades of investment in basic biomedical research, the focus is widening to include translational research — multidisciplinary scientific efforts directed at “accelerating therapy development”. Notable are efforts by the National Institute of Health, the National Cancer Institute, and EORTC (European Organization), EMBL (Europe), Singapore Genomics Institute, and National Translational Cancer Research Network (UK). In addition large donations by private foundations are also fueling growth in this key market segment.

 

The Clinical Diagnostic Market.    The clinical diagnostic market is an emerging growth opportunity that could be addressed by leveraging existing platforms like microfluidics, microarrays, and liquid chromatography/mass spectrometry. The clinical diagnostic market is viewed by us as an area for strategic growth.

 

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Chemical Analysis Markets

 

Our chemical analysis markets accounted for approximately 60 percent of revenue from the bio-analytical measurement business in 2006. Within chemical analysis, we focus primarily on the following areas: petrochemical, environmental, homeland security and forensics, and bioagriculture and food safety.

 

The Petroleum and Chemical Market.    The natural gas and petroleum refining markets use our products to measure and control the quality of their finished products and to verify the environmental safety of their operations. Petroleum refiners use our measurement solutions to analyze crude oil composition, perform raw material analysis, verify and improve refining processes and ensure the overall quality of gasoline, fuels, lubricants and other products. Solutions based on gas chromotography, liquid chromotography and mass spectrometry products are also used in the development, manufacturing and quality control of fine chemicals. Our gas chromatographs are also used to monitor consistent quality in the delivery of natural gas.

 

The Environmental Market.    Our gas chromatography, liquid chromatography and mass spectrometry solutions are used by the environmental market for applications such as laboratory and field analysis of chemical pollutants in air, water, soil and solid waste. Environmental industry customers include all levels of government, the industrial and manufacturing sectors, engineering and consulting companies, commercial testing laboratories and colleges and universities.

 

The Forensics and Homeland Security Market.    Our liquid chromatography, gas chromatography, mass spectrometry and microfluidics solutions are used by health and forensics laboratories in the U.S. and abroad, particularly in the analysis of evidence associated with crime or with the detection and identification of biological and chemical warfare agents. This instrumentation is either used in static or mobile laboratories. Customers include local, state, federal, and international law enforcement agencies and health laboratories.

 

The Bioagriculture and Food Safety Market.    Food safety industries apply the same general technologies for chemical analysis as the pharmaceutical and environmental markets, including gas and liquid chromatography and mass spectrometry. For example, our mass spectrometer portfolio, including recently introduced liquid chromatography mass spectrometers, are used to analyze residual pesticides in food. Additionally, bioagriculture industries seek to improve crops and foods by conducting research on these organisms, as well as testing for genetically modified content, using microarray and microfluidics solutions.

 

Bio-Analytical Measurement Products

 

A key factor in all of our bio-analytical measurement target markets is the need for new products that increase customer productivity and provide high quality data that enable decision-making by our customers.

 

 Microarray Products

 

Since announcing the launch of our DNA microarray program for the life sciences in December 1999, we have become a leading supplier of microarray solutions which we sell primarily to pharmaceutical companies and biotechnology companies in our for-profit markets, as well as academic and government funded organizations in our not-for-profit markets. Using our refined inkjet manufacturing process, we make highly sensitive 60-mer oligonucleotide, or oligo, microarrays. This unique inkjet process is highly flexible and accurate, enabling the faster manufacture of high quality custom microarrays. In 2006, we expanded our line of microarrays to offer a new line of high-density arrays providing enhanced genomics solutions for a variety of applications.

 

 Microfluidics Products

 

The Agilent 2100 bioanalyzer is the first commercial microfluidics product for the analysis of a wide range of biological molecules, including DNA, RNA, proteins and cells. The bioanalyzer chips allow sample quality assessment to be done in a fraction of the usual time using fewer samples and reagents than traditional gel electrophoresis. We also provide related software, which enables the bioanalyzer to be used for the development and manufacture of protein-based therapeutics. The bioanalyzer is commonly used in genomics laboratories and has enabled the standardization of RNA quality measurement.

 

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Gas Chromatography Products

 

Agilent is the world’s leading provider of gas chromatographs, both laboratory and portable models. A gas chromatograph (“GC”) is used to separate any gas, liquid or solid that can be vaporized and then detect the molecules present to determine their identity and quantity. We continue to expand the application space for our GCs with the development of new separation columns and product enhancements. Over the last three years, Agilent has introduced updated and advanced models of all of its major gas chromatography platforms.

 

Liquid Chromatography Products

 

A liquid chromatograph (“LC”) or a high performance liquid chromatograph (“HPLC”) is used to separate molecules of a liquid mixture to determine the quantity and identity of the molecules present. Used when sample vaporization is not an option, LC also separates and detects compounds to determine molecular identity and quantity. Our LC instruments are modular in construction and can be configured to form instruments that perform specific analyses. Agilent’s HPLC system, the Agilent 1100 Series, has sold over 60,000 systems since its introduction, and this year was replaced by its successor, the 1200 Series LC. The 1200 Series is an advanced version which enables true “fast chromatography” through both pressure and temperature control. As a leader in liquid chromatography, we continue to expand our application space with new HPLC columns and ongoing product enhancements. Our latest innovation, HPLC-Chip, is fully commercialized and creating demand for nano LC solutions across many markets.

 

Mass Spectrometry Products

 

A mass spectrometer (“MS”) identifies and quantifies chemicals based on a chemical’s molecular mass and on characteristic patterns of fragment masses that result when a molecule is broken apart. Mass spectrometry is an important tool in analyzing proteins and other biological entities that undergo transformations because it enables the understanding and characterization of their many different states. MS systems are typically used in combination with gas or liquid chromatographs. In the past three years, Agilent significantly expanded its mass spectrometry portfolio with a focus on reliability, sensitivity and ease of use. This year, we introduced two new LC/MS platforms, the Agilent 6410 Triple Quadrapole MS and the 6510 Quadrapole-Time of Flight MS. These new platforms serve new and growing markets for Agilent.

 

Software and Informatics Products

 

We provide software for instrument control, data acquisition, data analysis, laboratory content and business process management, and informatics. Our software facilitates the regulatory-compliant use of instruments in pharmaceutical quality assurance/quality control environments. In 2005, we completed the acquisitions of Scientific Software, Inc. and Silicon Genetics, Inc., expanding our portfolio of chromatography data systems and providing an entry into bioinformatics. The integration of these companies into Agilent has expanded our portfolio and market opportunities.

 

Consumables and Services

 

We also offer a broad range of consumable products, which support our LC, GC and MS technology platforms. These consumable products include chemical standards, instrument replacement parts, brand-specific chromatography columns and consumable supplies to meet our customers’ analysis needs. All of our products, which include generic and proprietary supplies, are designed to work together.

 

We offer a wide range of startup, operational, educational and compliance support services for our measurement and data handling systems. Our support services include maintenance, troubleshooting, repair and training for all of our chemical and bioinstrumentation analysis hardware and software products. Special service bundles have also been designed to meet the specific application needs of various industries.

 

Bio-Analytical Measurement Customers

 

We have roughly 21,000 customers, and as of the end of fiscal 2006, no single customer represented greater than 10 percent of the net revenue of the business. The bio-analytical measurement business is susceptible to seasonality in its orders and revenues primarily based on U.S. government and large pharmaceutical company budgets. The result is that our first and fourth fiscal quarters tend to deliver the strongest profits for this group. However, general economic trends, new product introductions and competition might overshadow this trend in any given year.

 

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Bio-Analytical Measurement Sales, Marketing and Support

 

Our sales and support delivery channels are aligned by key markets. We market products to our customers through direct sales, electronic commerce, resellers, manufacturers’ representatives and distributors. Additionally, we are optimizing our worldwide distribution capabilities to address high-growth opportunities such as the environmental, food safety and pharmaceutical markets in the Asia-Pacific region.

 

We use direct sales to market our solutions to all of our pharmaceutical and biopharmaceutical accounts, large- and medium-sized chemical customers and environmental accounts. Sales agents supplement direct sales by providing broader geographic coverage and coverage of smaller accounts. Our active reseller program augments our ability to provide more complete solutions to our customers. We sell our consumable products through distributors, telesales and electronic commerce.

 

We deliver our support services to customers in a variety of ways, including on-site assistance with repair or exchange of returned products, telephone support and self-diagnostic services provided over the Internet. We also offer special industry-focused service bundles that are designed to meet the specific needs of hydrocarbon processing, environmental, pharmaceutical and biopharmaceutical customers to keep instruments fully operational and compliant with the respective industry requirements. Our products typically come with standard warranties, and extended warranties are available for additional cost.

 

Bio-Analytical Measurement Manufacturing

 

Our manufacturing supports our diverse product range and customer-centric focus. We assemble highly configurable products to individual customer orders and make standard products to stock. We employ advanced manufacturing techniques and supply chain management systems to reduce costs and manufacturing cycle times. We selectively use third parties to provide manufacturing capabilities outside our core competencies, such as the manufacture of printed circuit assemblies and the delivery of shipment logistics. We have manufacturing facilities in California and Delaware in the U.S., China, Germany and Japan. We utilize just-in-time manufacturing and so typically do not maintain a high level of inventory.

 

Bio-Analytical Measurement Competition

 

The markets for analytical instruments in which we compete are characterized by evolving industry standards and intense competition. Our principal competitors in the life sciences arena include: Affymetrix, Inc., Applied Biosystems Inc., GE Healthcare, Invitrogen Corp., Thermo Electron Corp. and Waters Corp. Our principal competitors in the chemical analysis arena include: Applied Biosystems Inc., Perkin Elmer Corp., Shimadzu Corporation, Thermo Electron Corp. and Varian, Inc. Agilent competes on the basis of price, product performance, reliability, support quality, applications expertise and global channel coverage.

 

Bio-Analytical Measurement Government Regulation

 

The analysis products and related consumables marketed by our chemical analysis business are subject to regulation in the U.S. by the Environmental Protection Agency (“EPA”) under the Toxic Substances Control Act and by government agencies in other countries under similar laws. The Toxic Substances Control Act regulations govern, among other things, the testing, manufacture, processing and distribution of chemicals, the testing of regulated chemicals for their effects on human health and safety and import and export of chemicals. The Toxic Substances Control Act prohibits persons from manufacturing any chemical in the U.S. that has not been reviewed by EPA for its effect on health and safety, and placed on an EPA inventory of chemical substances. Therefore, we must continually adapt our chemical analysis products to changing regulations. If we fail to comply with the notification, record-keeping and other requirements in the manufacture or distribution of our products, the EPA can obtain an order from a court that would prohibit the further distribution or marketing of a product that does not comply or we could face fines, civil penalties or criminal prosecution.

 

Agilent Technologies Laboratories

 

Agilent Labs is our central research organization based in Santa Clara, California, with satellite offices in Beijing, China; Everett, Washington; Leuven, Belgium; and South Queensferry, Scotland. Agilent Labs engages primarily in two types of research: 1) applied research that leads to technology that can be transferred to our existing businesses in communications, electronics, life sciences and chemical analysis, and 2) research that creates new businesses that are outside of our current markets but within our fields of interest. Agilent Labs also provides technology integration across our company.

 

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Agilent Labs employs approximately 200 people. Agilent Labs’ technical staff have advanced degrees that cover a wide range of scientific fields, such as biology, bioinformatics, chemistry, computer science, distributed measurement, electrical engineering, image processing, materials science, mathematics, measurement software, optics, physics, physiology, semiconductor device design and signal processing.

 

General Infrastructure Organization

 

We provide support to our businesses through our general infrastructure and shared services organization. This support includes services in the areas of finance, legal, workplace services, human resources and information technology. These organizations are generally headquartered in Santa Clara, California, with services provided worldwide. As of the end of October 2006, our general infrastructure and shared services organizations employed approximately 2,750 people, which includes 200 Agilent Labs employees.

 

The following discussions of Research and Development, Backlog, Intellectual Property, Materials, Environmental, International Operations and Acquisition and Disposal of Material Assets include information common to each of our businesses.

 

Research and Development

 

Research and development (“R&D”) expenditures were $655 million in 2006, $650 million in 2005 and $599 million in 2004, the vast majority of which was company-sponsored. We anticipate that we will continue to have significant R&D expenditures in order to maintain our competitive position with a continuing flow of innovative, high-quality products and services.

 

Backlog

 

At October 31, 2006, our unfilled orders for the electronic measurement business amounted to approximately $700 million, as compared to approximately $670 million at October 31, 2005. At October 31, 2006, our unfilled orders for the bio-analytical measurement business were approximately $260 million, as compared to approximately $180 million at October 31, 2005. We expect that a large majority of the unfilled orders for both businesses will be delivered to customers within nine months. On average, our unfilled orders represent approximately two months’ worth of revenues. In light of this experience, backlog on any particular date, while indicative of short-term revenue performance, is not necessarily a reliable indicator of medium or long-term revenue performance.

 

Intellectual Property

 

Our general policy has been to seek patent and other intellectual property protection for those inventions and improvements likely to be incorporated into our products and services or to give us a competitive advantage. While we believe that our licenses, patents and applications have value, in general no single patent or license is in itself material. In addition, there can be no assurance that any of our proprietary rights will not be challenged, invalidated or circumvented, or that our rights will provide significant competitive advantages.

 

Materials

 

Our manufacturing operations employ a wide variety of semiconductors, electromechanical components and assemblies and raw materials such as plastic resins and sheet metal. Both our electronic and bio-analytical measurement businesses purchase materials from thousands of suppliers on a global basis. No single supplier is material, although some of the parts that require custom design work are not readily available from alternate suppliers due to their unique design or the length of time necessary for design work. Our long-term relationships with suppliers allow us to proactively manage technology road maps and product discontinuance plans and monitor their financial health. Even so, some suppliers may still extend their lead times, limit supplies, increase prices or cease to produce necessary parts for our products. If these are unique components, we may not be able to find a substitute quickly or at all. To address the potential disruption in our supply chain, we use a number of techniques, including qualifying multiple sources of supply, redesign of products for alternative components. In addition, while we generally attempt to keep our inventory at minimal levels, we do purchase of incremental inventory for supply buffer as circumstances warrant to protect the supply chain.

 

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Environmental

 

Our R&D, manufacturing and distribution operations involve the use of hazardous substances and are regulated under international, federal, state and local laws governing health and safety and the environment. We apply strict standards for protection of the environment and worker health and safety to sites inside and outside the U.S., even if not subject to regulation imposed by foreign governments. We believe that our properties and operations at our facilities comply in all material respects with applicable environmental laws and worker health and safety laws. However, the risk of environmental liabilities cannot be completely eliminated and there can be no assurance that the application of environmental and health and safety laws to Agilent will not require us to incur significant expenditures. We are also regulated under a number of international, federal, state and local laws regarding recycling, product packaging and product content requirements. These laws are gradually becoming more stringent and may in the future cause us to incur significant expenditures.

 

Some of our operations are located on properties that are known to have subsurface contamination undergoing remediation by HP. As part of our spin-off from HP in 1999, HP has agreed to retain the liability for the contamination, perform the required remediation and indemnify us with respect to claims arising out of the contamination. The determination of the existence and cost of any additional contamination caused by us could involve costly and time-consuming negotiations and litigation. While we expect that HP will meet its remediation and indemnification obligations in this regard, there can be no guarantee that it will do so. Under our agreement with HP, HP will have access to these properties to perform the remediation. HP has agreed to minimize interference with on-site operations at those properties during the course of the remediation, but there can be no guarantee that our operations will not be interrupted or that we will not be required to incur unreimbursed costs associated with the remediation. Remediation could also harm on-site operations and the future use and value of the properties.

 

In addition, some of these properties are undergoing remediation by HP under an order of an agency of the state in which the property is located. Although HP has agreed to indemnify us with respect to that subsurface contamination, it is possible that one or more of the governmental agencies will require us to be named on any of these orders. The naming of Agilent will not affect HP’s obligation to indemnify us with regard to these matters.

 

We are liable and are indemnifying HP for any contamination found at all facilities transferred to us by HP excluding the properties undergoing remediation. In addition, we are indemnifying HP for any liability associated with past non-compliance with environmental laws regulating ongoing operations at all properties transferred to us by HP, as well as at sold or discontinued businesses that are related to our businesses. While we are not aware of any material liabilities associated with such indemnified matters, there is no guarantee that such contamination or regulatory non-compliance does not exist, and will not expose us to material liability in the future.

 

We are being indemnified by HP with respect to all environmental liabilities for which HP accrued a reserve, and we are not aware of any material environmental liabilities being assumed by us which are not subject to the indemnity.

 

International Operations

 

Our net revenue originating outside the U.S., as a percentage of our total net revenue, was approximately 66 percent in fiscal 2006, 64 percent in fiscal 2005 and 65 percent in fiscal 2004, the majority of which was from customers other than foreign governments. Approximately 13 percent of our annual revenues in each of the last three years was derived from Japan. Revenues from external customers are generally attributed to countries based upon the location of the Agilent sales representative.

 

Long-lived assets located outside of the U.S., as a percentage of our total long-lived assets, was approximately 55 percent in fiscal year 2006, 50 percent in fiscal year 2005 and 54 percent in fiscal year 2004. Approximately 19, 17 and 16 percent of our long-lived assets were located in Japan in fiscal years 2006, 2005 and 2004, respectively.

 

Most of our sales in international markets are made by foreign sales subsidiaries. In countries with low sales volumes, sales are made through various representatives and distributors. However, we also sell into international markets directly from the U.S.

 

Our international business is subject to risks customarily encountered in foreign operations, including interruption to transportation flows for delivery of parts to us and finished goods to our customers, changes in a specific country’s or region’s political or economic conditions, trade protection measures, import or export licensing requirements, consequences from changes in tax laws and regulatory requirements, difficulty in staffing and managing widespread operations, differing labor regulations, differing protection of intellectual property and geopolitical turmoil, including terrorism and war. We are also exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales and expenses, and assets and liabilities denominated in currencies other than the local functional currency, and may also become subject to interest rate risk inherent in any debt we incur, or investment and finance receivable portfolios we hold. The U.S. and international community’s response to recent terrorist activities could exacerbate these risks. For example, there may be an

 

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increased risk of political unrest in regions where we have significant manufacturing operations such as Southeast Asia. However, we believe that our international diversification provides stability to our worldwide operations and reduces the impact on us of adverse economic changes in any single country. Financial information about our international operations is contained in Note 23, “Segment Information”, to our consolidated financial statements.

 

Acquisition and Disposal of Material Assets

 

On November 28, 2005, we completed the sale of our stake in Lumileds Lighting International, B.V. (“Lumileds”) to Philips pursuant to a Share Purchase Agreement (the “Share Purchase Agreement”) dated as of August 12, 2005 among Agilent, Agilent LED International, Philips Lumileds Holding B.V. and Philips. Under the terms of the Share Purchase Agreement, Agilent received $949 million in cash proceeds, as well as approximately $51 million in repayment of outstanding advances to Lumileds and interest due to Agilent.

 

In December 2005, we completed the sale of substantially all the assets of our semiconductor products business to Avago pursuant to an Asset Purchase Agreement dated as of August 14, 2005 and amended November 30, 2005 (the “Asset Purchase Agreement”). Under the terms of the Asset Purchase Agreement, Agilent received approximately $2.6 billion in cash proceeds.

 

On October 31, 2006, we distributed Agilent’s equity interest in Verigy by means of a dividend to our stockholders. Prior to the distribution, on June 1, 2006, Agilent transferred substantially all of the assets and liabilities of its semiconductor test solutions business to Verigy, then a wholly owned subsidiary of Agilent. In June and July 2006, Verigy sold approximately 8.7 million of its ordinary shares, or approximately 15 percent of its outstanding shares, in an initial public offering. On October 31, 2006, the aggregate market value of the Verigy shares which were distributed was $840 million.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Current Report on Form 8-K. This report contains forward-looking statements including, without limitation, statements regarding trends, seasonality, cyclicality and growth in the markets we sell into, our strategic direction, our future effective tax rate and tax valuation allowance, earnings from our foreign subsidiaries, remediation activities, new product and service introductions, changes to our manufacturing processes, the use of contract manufacturers, the impact of local government regulations on our ability to pay vendors or conduct operations, our liquidity position, our ability to generate cash from continuing operations, growth in our businesses, our investments, the potential impact of adopting new accounting pronouncements, our financial results, our purchase commitments, our contributions to our pension plans, the selection of discount rates and recognition of any gains or losses for our benefit plans, our cost-control activities, savings and headcount reduction recognized from our restructuring programs and the divestiture of our semiconductor products and semiconductor test businesses, our stock repurchase program, our transition to lower-cost regions, the existence or length of an economic recovery that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to various factors, including those discussed in Item 1A and elsewhere in this Form 8-K.

 

Reclassifications

 

Amounts in the consolidated financial statements as of and for the years ended October 31, 2005 and October 31, 2004 have been reclassified to conform to the presentation used in 2006. See Note 3, “Discontinued Operations of our Semiconductor Products Business” and Note 4, “Discontinued Operations of our Semiconductor Test Solutions Business”, to our consolidated financial statements for further information regarding the reclassification of financial information for discontinued operations. See Note 7, “Equity in Net Income of Unconsolidated Affiliate and Gain on Sale — Lumileds” to our consolidated financial statements for reclassification of equity in net income.

 

Overview and Executive Summary

 

Agilent, incorporated in Delaware in May 1999, is the world’s premier measurement company, providing core bio-analytical and electronic measurement solutions to the communications, electronics, life sciences and chemical analysis industries. Prior to our initial public offering of 16 percent of our stock in November 1999, we were a wholly-owned subsidiary of Hewlett-Packard Company (“HP”). HP distributed the remaining 84 percent of our stock to its stockholders on June 2, 2000 in the form of a stock dividend.

 

Our fiscal year end is October 31. Unless otherwise stated, all years and dates refer to our fiscal year.

 

Agilent currently has two businesses focused on bio-analytical measurement and electronic measurement. During the past year, we divested two of our historical businesses, the semiconductor products business and the semiconductor test solutions business. In December 2005, we sold the semiconductor products business and recorded a gain of approximately $1.8 billion. In October 2006, we completed the distribution to our stockholders of our semiconductor test solutions business. We have reflected both the semiconductor products business and the semiconductor test solutions business as discontinued operations for all periods presented in this Current Report on Form 8-K.

 

Agilent’s net revenue from continuing operations in 2006 was $4,973 million, an increase of 6 percent in comparison to 2005. In our bio-analytical business, net revenue in 2006 increased 10 percent in comparison to 2005. Demand increased across all markets in bio-analytical measurement with strongest growth occurring in biotechnology solutions. In our electronic measurement business, net revenue in 2006 increased 4 percent in comparison to 2005. The electronic measurement business saw growth in our general purpose segments, led by aerospace /defense and semiconductor design and manufacturing. Agilent’s total net revenue in 2005 increased 3 percent in comparison to 2004.

 

Net income in 2006 was $3,307 million, which included the income from and gain on sale of our semiconductor products business for $1,816 million and the sale of our investment in Lumileds for a gain of $901 million. Net income in 2005 was $327 million, a decrease of 11 percent in comparison to $369 million in 2004. The decrease in total net income for 2005 was driven by a $174 million decrease in net income associated with discontinued operations offset by a $132 million increase in net income from continuing operations.

 

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In 2006, we generated operating cash flows of $431 million and had a cash and cash equivalent balance as of October 31, 2006 of $2,262 million. In 2005, we generated operating cash flows of $656 million and had a cash and cash equivalent balance as of October 31, 2005 of $2,226 million.

 

The following significant events were accomplished in fiscal year 2006:

 

•                  In November 2005, we finalized the sale of our investment in Lumileds to Philips for $949 million plus the repayment of $51 million of the outstanding principal debt and interest due to us.

 

•                  In December 2005, we sold our semiconductor products business to Avago. We received approximately $2.6 billion in cash proceeds.

 

•                  In October 2006, we completed the spin-off of our semiconductor test solutions business. The aggregate market value of ordinary shares distributed to Agilent stockholders was approximately $840 million.

 

•                  In June 2006, we completed a stock repurchase program of $4.466 billion of our common stock and in September 2006 we commenced another stock repurchase program for up to $2.0 billion dollars, to be completed over the next 2 years.

 

•                  We completed the actions necessary to reduce our infrastructure costs by approximately $450 million.

 

Having completed the disposal of two semiconductor-related businesses, Agilent is less exposed to the highly cyclical semiconductor market. Therefore, we expect that Agilent’s current operating model will experience lower cyclicality in revenue and costs than we experienced in prior years. Looking forward, we are mindful of the economic uncertainties in the year ahead and Agilent’s focus is to leverage, through higher sustainable growth, the more stable operating model we’ve built. Our goal is to grow our revenue at a faster rate than the electronic measurement and bio-analytical measurement markets, primarily through increasing market share and complementary acquisitions which will add to our top line growth.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s best knowledge of current events and actions that may impact the company in the future, actual results may be different from the estimates. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, restructuring and asset impairment charges, inventory valuation, investment impairments, share-based compensation, retirement and post-retirement plan assumptions, valuation of long-lived assets and accounting for income taxes.

 

Revenue recognition. We enter into agreements to sell products (hardware or software), services, and other arrangements (multiple element arrangements) that include combinations of products and services. Revenue from product sales, net of trade discounts and allowances, is recognized provided that persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. Delivery is considered to have occurred when title and risk of loss have transferred to the customer. Revenue is reduced for estimated product returns, when appropriate. For sales that include customer-specified acceptance criteria, revenue is recognized after the acceptance criteria have been met. For products that include installation, if the installation meets the criteria to be considered a separate element, product revenue is recognized upon delivery, and recognition of installation revenue occurs when the installation is complete. Otherwise, neither the product nor the installation revenue is recognized until the installation is complete. Revenue from services is deferred and recognized over the contractual period or as services are rendered and accepted by the customer. When arrangements include multiple elements, we use objective evidence of fair value to allocate revenue to the elements and recognize revenue when the criteria for revenue recognition have been met for each element. The amount of product revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements and if so, whether vendor-specific objective evidence of fair value exists for those elements. Changes to the elements in an arrangement and the ability to establish vendor-specific objective evidence for those elements could affect the timing of the revenue recognition. Most of these conditions are subjective and actual results could vary from the estimated outcome, requiring future adjustments to revenue.

 

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Restructuring and asset impairment charges. The three main components of our restructuring plans are related to workforce reductions, the consolidation of excess facilities and asset impairments. Workforce reduction charges are accrued when it is determined that a liability has been incurred, which is generally after individuals have been notified of their termination dates and expected severance payments. Plans to consolidate excess facilities result in charges for lease termination fees and future commitments to pay lease charges, net of estimated future sublease income. We recognize charges for consolidation of excess facilities when we have vacated the premises. These estimates were derived using the guidance of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), Staff Accounting Bulletin 100, “Restructuring and Impairment Charges” (“SAB 100”), Emerging Issues Task Force 94-3, “Liability Recognition for Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)” (“EITF 94-3”) and lastly, SFAS No. 146 “Accounting for Exit or Disposal Activities” (“SFAS No. 146”). If the amounts and timing of cash flows from restructuring activities are significantly different from what we have estimated, the actual amount of restructuring and asset impairment charges could be materially different, either higher or lower, than those we have recorded.

 

Inventory valuation. We assess the valuation of our inventory on a quarterly basis and periodically write down the value for estimated excess and obsolete inventory based upon estimates about future demand and actual usage. Such estimates are difficult to make under most economic conditions. The excess balance determined by this analysis becomes the basis for our excess inventory charge. Our marketing department plays a key role in our excess inventory review process by providing updated sales forecasts, managing product rollovers and working with manufacturing to maximize recovery of excess inventory. If actual market conditions are less favorable than those projected by management, additional write-downs may be required. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold to customers, resulting in lower cost of sales and higher income from operations than expected in that period.

 

Investment impairments. We recognize an impairment charge when the decline in the fair value of our publicly traded equity securities and our cost-method investments below their cost basis are judged to be other-than-temporary. Significant judgment is used to identify events or circumstances that would likely have a significant adverse effect on the future use of the investment. We consider various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, forecasted recovery, the financial condition and near-term prospects of the investee, and our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

 

Share-based compensation. We account for share-based awards in accordance with Statement of Financial Accounting Standards No. 123(R), Shared-Based Payment (“SFAS No. 123(R)”) which was effective November 1, 2005 for Agilent. Under the new standard, share-based compensation expense is primarily based on estimated grant date fair value which is generally using the Black-Scholes option pricing model and is recognized on a straight-line basis for awards granted after November 1, 2005 over the vesting period of the award. For awards issued prior to November 1, 2005, we recognize share-based compensation expense based on FASB Interpretation 28 “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans an interpretation of APB Opinions No. 15 and 25”, which provides for accelerated expensing. Our estimate of share-based compensation expense requires a number of complex and subjective assumptions including our stock price volatility, employee exercise patterns (expected life of the options), future forfeitures and related tax effects. We consider several factors in estimating the expected life of our options granted, including the expected lives used by a peer group of companies and the historical option exercise behavior of our employees, which we believe are representative of future behavior. We estimate the stock price volatility using the implied volatility of Agilent’s publicly traded stock options. We have determined that implied volatility is more reflective of market conditions and a better indicator of expected volatility than a combined method of determining volatility. The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. Although we believe the assumptions and estimates we have made are reasonable and appropriate, changes in assumptions could materially impact our reported financial results.

 

Retirement and post-retirement benefit plan assumptions. Retirement and post-retirement benefit plan costs are a significant cost of doing business. They represent obligations that will ultimately be settled sometime in the future and therefore are subject to estimation. Pension accounting is intended to reflect the recognition of future benefit costs over the employees’ average expected future service to Agilent based on the terms of the plans and investment and funding decisions. To estimate the impact of these future payments and our decisions concerning funding of these obligations, we are required to make assumptions using actuarial concepts within the framework of accounting principles generally accepted in the U.S. Two critical assumptions are the discount rate and the expected long-term return on plan assets. Other important assumptions include the health care cost trend rate, expected future salary increases, expected future increases to benefit payments, expected retirement dates, employee turnover, retiree mortality rates, and portfolio composition. We evaluate these assumptions at least annually.

 

The discount rate is used to determine the present value of future benefit payments at the measurement date — October 31 for U.S. plans and September 30 for non-U.S plans. For U.S. plans, the discount rate was determined by matching the expected plan benefit payments against the cash flows from a hypothetically constructed portfolio of high quality corporate bonds. The average yield of this hypothetical bond portfolio was used as a proxy for setting the discount rate. The discount rate

 

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increased slightly over the prior year to 6.0 percent. Lower discount rates increase present values and subsequent year pension expense; higher discount rates decrease present values and subsequent year pension expense. The discount rate for non-U.S. plans was generally based on published rates for high quality corporate bonds. In recent years, decreasing interest rates, particularly outside the U.S., have increased our benefit obligations and our net plan costs. These increases have been in large part offset by a declining number of plan participants as a result of our various restructuring programs. The entire impact of declining discount rates is not recognized immediately under current accounting standards. As of October 31, 2006, delayed recognition of the impact of declining discount rates was the primary factor in approximately $297 million in unrecognized actuarial losses for non-U.S. plans. These losses are being recognized over the expected average future service lives of plan participants— ranging from 12 to 18 years depending on the plan.

 

The expected long-term return on plan assets is estimated using current and expected asset allocations, as well as historical and expected returns. As of October 31, 2006, delayed recognition of better than expected investment performance was a significant factor in $63 million of unrecognized actuarial gains for U.S. plans. These gains will be recognized over approximately 12 years or the expected average future service life for U.S. plan participants. A one percent change in the estimated long-term return on plan assets for 2006 would result in a $6 million impact on U.S. pension expense and a $15 million impact on non-U.S. pension expense.

 

The net periodic pension and post-retirement benefit costs recorded in continuing operations were $81 million in 2006, $106 million in 2005 and $122 million in 2004. Due to final payouts from our Excess Plan in the U.S. in the first quarter of 2007, we expect a settlement under SFAS No. 88, Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits. We cannot currently estimate this impact.

 

Valuation of long-lived assets. We performed our annual goodwill impairment analysis in the fourth quarter of 2006. Based on our estimates of forecasted discounted cash flows and our market capitalization at that time, we concluded that our goodwill was not impaired. We have also assessed the recoverability of our long-lived assets, by determining whether the carrying value of such assets will be recovered through undiscounted future cash flows. Asset impairments primarily consist of property, plant and equipment and are based on an estimate of the amounts and timing of future cash flows related to the expected future remaining use and ultimate sale or disposal of buildings and equipment net of costs to sell. During 2006, we incurred $42 million of asset impairment charges, which includes approximately $3 million recorded in discontinued operations. In addition, we recorded $1 million of investment impairment charges during 2006.

 

The process of evaluating the potential impairment of goodwill and other intangibles is highly subjective and requires significant judgment. We estimate expected future cash flows of our various businesses, which operate in a number of markets and geographical regions. We then determine the carrying value of these businesses. We exercise judgment in assigning and allocating certain assets and liabilities to these businesses. We then compare the carrying value including goodwill and other intangibles to the discounted future cash flows. If the total of future cash flows is less than the carrying amount of the assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. Estimates of the future cash flows associated with the assets are critical to these assessments. Changes in these estimates based on changed economic conditions or business strategies could result in material impairment charges in future periods.

 

The process of evaluating the potential impairment of long-lived assets such as our property, plant and equipment is also highly subjective and requires significant judgment. In order to estimate the fair value of long-lived assets, we typically make various assumptions about the future prospects for the business that the asset relates to, consider market factors specific to that business and estimate future cash flows to be generated by that business. Based on these assumptions and estimates, we determine whether we need to take an impairment charge to reduce the value of the asset stated on our balance sheet to reflect its estimated fair value. Assumptions and estimates about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including external factors such as the real estate market, industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, changes in assumptions and estimates could materially impact our reported financial results.

 

Accounting for income taxes. Significant management judgment is required in determining our provision for income taxes and in determining whether deferred tax assets will be realized in full or in part. When it is more likely than not that all or some portion of specific deferred tax assets such as net operating losses or foreign tax credit carryforwards will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that cannot be realized. Realization is based on our ability to generate sufficient future taxable income. During 2003, we established valuation allowances for the deferred tax assets of the U.S. and selected entities in foreign jurisdictions. The valuation allowance was determined in accordance with the provisions of SFAS No. 109 which requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable. Such assessment is required on a jurisdiction-by-jurisdiction

 

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basis. Cumulative losses incurred in the U.S. and selected entities in foreign jurisdictions in recent years represented sufficient negative evidence, which made it difficult for positive evidence to overcome. Accordingly, a full valuation allowance was recorded in all instances. We intend to maintain a full valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance. Profits or losses incurred in the U.S. and selected entities in foreign jurisdictions affect the ongoing amount of the valuation allowance. We expect that the effective tax rate applied to our pre-tax income in fiscal 2007 will be lower than it otherwise would be because future income taxes in the U.S. and selected entities in foreign jurisdictions will be offset by adjustments to the valuation allowance to effectively eliminate any tax expense or benefit in those jurisdictions. Income taxes will continue to be recorded for various jurisdictions subject to the need for valuation allowances in those jurisdictions.

 

We have not provided for U.S. federal income and foreign withholding taxes on the undistributed earnings of our foreign subsidiaries because we intend to reinvest such earnings indefinitely. Should we decide to remit this income to the U.S. in a future period, our provision for income taxes may increase materially in that period.

 

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax law and regulations in a multitude of jurisdictions. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and interest will be due. If our estimate of income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.

 

Restructuring and Asset Impairment

 

We initiated several restructuring plans in prior periods: the 2001 Plan, the 2002 Plan and the 2003 Plan (“Prior Plans”). The workforce reduction portion of the Prior Plans was completed during fiscal year 2005. In the fourth quarter of fiscal year 2005, due to the then pending divestitures of our semiconductor products and semiconductor test businesses, we launched a new restructuring plan (“2005 Plan”) to reduce our workforce and facility footprint to match a smaller organizational size.

 

In 2006 we continued execution of the 2005 plan and recorded restructuring and asset impairment charges of $186 million, of which $111 million was for workforce reduction expenses and the remainder for facility impairment and lease termination expenses. As of October 31, 2006, our accrual for pending workforce reduction costs was $13 million, which is down from the $44 million balance from the prior year as the workforce reduction program winds down. Our accrual for the consolidation of excess facilities, however, increased $9 million from the prior year due to significant facility consolidation efforts that were initiated during the past year. The workforce reduction portion of the 2005 plan is expected to be substantially completed in fiscal year 2007, but we will continue to make lease payments on some of our excess facility space for approximately the next five years.

 

The restructuring accrual is recorded in other accrued liabilities and other long-term liabilities on the consolidated balance sheet. For further details on our restructuring plans, see Note 19, “Restructuring and Asset Impairment”, to our consolidated financial statements.

 

Foreign Currency

 

Our revenues, costs and expenses, and monetary assets and liabilities are exposed to changes in foreign currency exchange rates as a result of our global operating and financing activities. We hedge revenues, expenses and balance sheet exposures that are not denominated in the functional currencies of our subsidiaries on a short term and anticipated basis. We do experience some fluctuations within individual lines of the consolidated statement of operations and balance sheet because our hedging program is not designed to offset the currency movements in each category of revenues, expenses, monetary assets and liabilities. Our hedging program is designed to hedge currency movements on a relatively short-term basis (rolling twelve month period). Therefore, we are exposed to currency fluctuations over the longer term. For example, over the last three years the U.S dollar has weakened against the Euro and the British pound and although we successfully hedged currency movements in those currencies each year, we have experienced a net increase in reported expenses in Europe as a result of currency fluctuations over this time period.

 

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Results from Continuing Operations

 

The following discussion excludes our semiconductor products business and our semiconductor test solutions business as their results are reported as discontinued operations for all periods presented in this Current Report on Form 8-K.

 

In the beginning of the third quarter of 2007, we moved the nanotechnology measurement business from the electronics measurement segment to the bio-analytical measurement segment to more closely align with the new materials sciences business in that segment. All historical segment numbers have been recast to conform to this change in reportable segments.

 

Income from continuing operations in 2006 was $1,437 million, which included the gain on sale of our Lumileds investment of $901 million. In 2005, we recorded $191 million in income from continuing operations compared to $59 million recorded in 2004.

 

Orders and Net Revenue

 

		Years Ended October 31,										2006 over 2005		2005 over 2004
		2006				2005			2004			% Change		% Change
		(in millions)
Orders		$		5,075		$	4,773		$	4,512		6	%	6	%
Net revenue:
Products		$	4,125			$	3,854		$	3,783		7	%	2	%
Services and other		848				831			773			2	%	8	%
Total net revenue		$	4,973			$	4,685		$	4,556		6	%	3	%

 

		Years Ended October 31,						2006 over 2005		2005 over 2004
		2006		2005		2004		Ppts Change		Ppts Change
% of total net revenue:
Products		83	%	82	%	83	%	1 ppt		(1) ppt
Services and other		17	%	18	%	17	%	(1) ppt		1 ppt
Total		100	%	100	%	100	%

 

Net revenue in 2006 was $4,973 million, a 6 percent increase over the $4,685 million net revenue recorded in 2005. Net revenue in 2005 was $4,685 million, a 3 percent increase over the $4,556 million net revenue recorded in 2004.

 

Bio-analytical measurement results were consistent with our normal seasonal pattern and reflected increased demand across virtually all of our markets. Our bio-analytical business is comprised of two areas, life science and chemical analysis. In life science, growth was due to demand from biotechnology customers and the impact of new product introduction in LC, LCMS and microarrays. In chemical analysis growth was driven by demand for environmental and food testing solutions.. Our electronic measurement business saw a 4 percent revenue growth, solid profitability, and good return on invested capital. Growth was driven by underlying customer demand in several key markets, including semiconductor design and verification, and consumer electronics design and manufacturing. However, growth was negatively impacted because of two factors: First, capital spending in the wireline segment was constrained by mergers in the customer base (both NEMs and communication service providers) as well as uncertainty in service providers’ investments as they transition from fixed-line to IP-based networks and services. Second, we had a slowdown in our wireless monitoring business, as the industry transitions from 2G to 3G networks amid stronger competition.

 

Services and other revenue includes revenue generated from servicing our installed base of products, warranty extensions and consulting. In 2006 and 2005, services and other revenue increased over the prior years as our installed base of products increased and a change in standard warranty from three years to one year drove a higher volume of extended warranty business.

 

Costs and Expenses

 

		Years Ended October 31,									2006 over 2005		2005 over 2004
		2006			2005			2004			Change		Change
Gross margin on products		56		%	53		%	49		%	3 ppts		4 ppts
Gross margin on services and other		39		%	39		%	41		%	—		(2) ppts
Total gross margin		53		%	50		%	47		%	3 ppts		3 ppts
Operating margin		9		%	5		%	1		%	4 ppts		4 ppts
Research and development		$	655		$	650		$	599		1	%	9	%
Selling, general and administrative		$	1,660		$	1,498		$	1,502		11	%	—

 

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The following tables present the gross inventory charges and sales of previously reserved inventory, respectively:

 

Gross Inventory Charges

 

		Years Ended October 31,
		2006			2005			2004
		(in millions)
Bio-analytical measurement		$	8		$	4		$	3
Electronic measurement		29			40			13
Unallocated charges and other (1)		1			15			—
Total		$	38		$	59		$	16

 

Sales of Previously Reserved Inventory

 

		Years Ended October 31,
		2006			2005			2004
		(in millions)
Bio-analytical measurement		—			$	1		$	3
Electronic measurement		14			7			9
Total		$	14		$	8		$	12

 

(1)           Unallocated charges primarily relate to inventory write-downs for exited product lines, which management has not reflected in segment results.

 

In 2006, total gross margin increased 3 percentage points in comparison to 2005. This improvement was the result of volume increases and cost efficiencies, in particular, restructuring activities, material cost reductions and overall operational improvements. In addition, we benefited from the refunctionalization of some general corporate expenses out of costs of products and services and into operating expense, which is consistent with our current less manufacturing-intensive operations following the disposal of our semiconductor products and semiconductor test solutions businesses. In 2005, total gross margin increased 3 percentage points in comparison to 2004. The increase was attributable to our efforts to lower our cost structure and refine our operating model. In 2005, we benefited from a more variable cost structure through use of contract manufacturers and we reduced manufacturing costs by shifting production to lower-cost regions. These benefits continued through 2006.

 

Operating margins in 2006 increased 4 percentage points as compared to 2005 due to continued restructuring activities and tighter controls on spending. In 2005 operating margin increased 4 percentage points compared to 2004. This was primarily due to savings from our restructuring efforts and a decrease in restructuring costs for research and development and selling, general and administrative expenses in 2005 compared to 2004.

 

Our research and development efforts focus on potential new products and product improvements covering a wide variety of technologies, none of which is individually significant to our operations. We conduct five types of research and development: basic research, which contributes to the fundamental understanding of areas critical to our future; foundation technologies, which enables fundamental advances across all businesses; communications, which creates technologies to enable pervasive access to information; life sciences, which enables next-generation pharmaceuticals and improved patient outcomes; and measurement, which provides critical advances in test and measurement electronics and systems. Our research seeks to improve on various technical competencies in electronics such as compound semiconductor devices, digital imaging systems and microfabrication technologies; software, systems and solutions such as applied mathematics, knowledge management and measurement science; life sciences such as computational biology, molecular diagnostics and high-throughput measurements; and photonics, such as precision automation technology, optical switching and high-speed optical links. In each of these research fields, we conduct research that is focused on specific product development for release in the short-term as well as other research that is intended to be the foundation for future products over a longer time-horizon. Some of our product development research is designed to improve on the more than 20,000 products already in production, other research is on major new product releases, and yet other focused on developing new product segments for the future. Because of the large number of new and existing products and research and development projects across all of our businesses, it is difficult to quantify the impact of any specific products or projects either in the periods presented or on a forward looking basis.

 

Income from continuing operations in 2006 was $1,437 million, which includes a gain of $901 million for the sale of our investment in Lumileds, an equity investment. The remaining increase in income from continuing operations, in comparison to the prior year, is attributable to an increase in revenue of $288 million, an increase in net interest income of $64 million and also attributable to the gain recorded in connection with the sale of two properties located in California for a net gain of

 

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approximately $121 million. Income from continuing operations in 2005 was $191 million, an increase of approximately $132 million in comparison to 2004. The increase was primarily driven by reduction in costs and expenses due to the incremental benefits of our restructuring programs and discretionary spending controls.

 

At October 31, 2006, our headcount, on a continuing operations basis, was approximately 18,700 compared to 19,400 in 2005 and 19,800 in 2004. The decrease in workforce is predominantly due to infrastructure reduction in light of the recent business divestitures.

 

Provision for Income Taxes from Continuing Operations

 

		Years Ended October 31,
		2006			2005			2004
		(in millions)
Provision for income taxes		$	91		$	142		$	57

 

For the year ended October 31, 2006, we recorded an income tax provision of $91 million on continuing operations as compared with an income tax provision of $142 million and $57 million on continuing operations for the years ended October 31, 2005 and 2004, respectively. The 2006 provision was recorded for taxes on income generated in jurisdictions other than the U.S. Income generated in the U.S. and, to a much lesser extent, losses incurred in certain foreign jurisdictions were offset by adjustments to their respective valuation allowances. The income tax provision also includes a benefit of $29 million related to the resolution of domestic tax-related issues for years covered by a Tax Sharing Agreement between Agilent and Hewlett-Packard. The Tax Sharing Agreement is related to the 2000 spin-off of Agilent from Hewlett-Packard.

 

For 2006, the annual effective tax rate was 6.0 percent on continuing operations. The 6.0 percent continuing operations tax rate reflects taxes on the sale of our Lumileds joint venture at an effective tax rate of zero in the U.S. (due to the operation of the valuation allowance) and at low effective tax rates in other jurisdictions. In addition, the low continuing operations tax rate is a result of the $29 million benefit related to the resolution of issues covered by a Tax Sharing Agreement between Agilent and Hewlett-Packard. The tax rate for continuing operations does not include the impact of income from low-tax jurisdictions generated by our semiconductor products business and our semiconductor test solutions business which are now reported as discontinued operations.

 

For 2005, the annual effective tax rate was 42.6 percent on continuing operations. This tax rate for continuing operations does not include the impact of income from low-tax jurisdictions generated by our semiconductor products business and our semiconductor test solutions business which are now reported as discontinued operations. Additionally, the repatriation tax of the American Jobs Creation Act of 2004 (“AJCA”) caused a 7.2 percent increase in the 2005 effective tax rate as during 2005 we decided to repatriate earnings on which we had not previously provided U.S. taxes.

 

For 2004, the annual effective tax rate was 49.1 percent on continuing operations. This tax rate for continuing operations does not include the impact of income from low-tax jurisdictions generated by our semiconductor products business and our semiconductor test solutions business which are now reported as discontinued operations. In addition, non-deductible goodwill increased the rate by 5.6 percent.

 

On October 22, 2004, the AJCA was signed into law. The AJCA created a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. In the fourth quarter of fiscal 2005, we distributed cash from our foreign subsidiaries and reported an extraordinary dividend (as defined in the AJCA) of $970 million and a related tax liability of approximately $48 million in our fiscal 2005 federal income tax return. For 2005, $23 million of the $48 million is provided for in the discontinued operations’ provision for income taxes, while the remaining is provided for in the continuing operations’ provision for income taxes.

 

Agilent enjoys tax holidays in several different jurisdictions, most significantly in Singapore, Malaysia and Switzerland. The tax holidays provide lower rates of taxation on certain classes of income and require various thresholds of investments and employment in those jurisdictions. As a result of the incentives, the impact of the tax holidays decreased income taxes by $76 million, $54 million and $96 in 2006, 2005 and 2004, respectively. It is anticipated that these tax holidays will benefit Agilent in a similar way in 2007.

 

During 2003, we established valuation allowances for the deferred tax assets of the U.S. and selected entities in foreign jurisdictions. The valuation allowances were determined in accordance with the provisions of SFAS No. 109 which require an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets

 

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are recoverable. Such assessment is required on a jurisdiction by jurisdiction basis. Cumulative losses incurred in the U.S and certain entities in foreign jurisdictions in recent years represented sufficient negative evidence under SFAS No. 109 to require full valuation allowances. We intend to maintain full valuation allowances until sufficient positive evidence exists to support the reversal.

 

In connection with an Internal Revenue Service (IRS) audit of our U.S. federal income tax returns for 2000 through 2002, we received a Notice of Proposed Adjustment (NOPA) in October 2006 in which the IRS claims significant increases to our U.S. taxable income which could result in a commensurate increase in our U.S. income taxes payable. This claim relates to the use of Agilent’s brand name by our foreign affiliates. We expect to receive a Revenue Agent’s Report (RAR) with respect to this claim in due course in which we anticipate the IRS will assert a significant aggregate tax deficiency, plus interest and possible penalties. We believe that the claimed IRS adjustments are inconsistent with applicable tax laws and that the chances of the IRS prevailing on the claim are remote. Accordingly, we will oppose the claimed adjustments vigorously. In accordance with SFAS No. 5, “Accounting for Contingencies”, we have not accrued an income tax liability in our October 31, 2006 financial statements as we believe the possibility that the IRS will be successful in its claim for the adjustment is remote.

 

For all U.S. and other tax jurisdictions, we recognize potential liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes and interest will be due. If our estimate of income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.

 

Equity in Net Income of Unconsolidated Affiliate and Gain on Sale — Lumileds

 

Lumileds was a global joint venture between Agilent and KoninklijkePhilips Electronics N.V.(“Philips”). Lumileds manufactures high-power light emitting diodes and solid-state lighting solutions. Agilent sold its interest in Lumileds on November 28, 2005. Pursuant to the Share Purchase Agreement, upon closure of the sale transaction, the Joint Venture Agreement and the ancillary agreements were terminated. The purchase price paid by Philips under the Share Purchase Agreement was $949 million. In addition, Lumileds repaid the $51 million of outstanding principal debt and accrued interest under the Credit Agreement, dated as of November 30, 2001.

 

Our equity in the net income of our unconsolidated affiliate including the gain on sale of our interest in Lumileds was $901 million in 2006, $42 million in 2005 and $29 million in 2004.

 

General Infrastructure and Shared Services

 

For Agilent overall, in response to the divestiture and spin-off of our semiconductor businesses, we have decreased our infrastructure costs primarily through restructuring programs and streamlining our operations. We have reduced the number of employees in our workforce that provide support services such as finance, IT and workplace services and moved many of our global shared services operations sites to lower cost regions. In 2006, savings for infrastructure costs associated with restructuring plans, IT data center and networking costs, IT project investments and cost controls were approximately $280 million compared with 2005. We passed these savings on to all our businesses according to usage of related services. The general infrastructure and shared services functions ended 2006 with approximately 2,750 employees, a decrease of approximately 1,160 employees from one year ago and a decrease of approximately 1,300 employees from two years ago. Over the past two years, general infrastructure and shared services headcount has dropped by approximately 1,190 people in the U.S. and Europe and has also dropped by approximately 110 people in Asia. Although reductions in infrastructure costs are largely complete as we have divested our semiconductor products business and spun-off our semiconductor test solutions business, we expect that a few key infrastructure areas such as IT and workplace services will continue to see savings in the next fiscal year.

 

Segment Overview

 

During 2006, we completed the divestiture of our semiconductor products business and spin-off of our semiconductor test solutions business See Note 3, “Discontinued Operations of Our Semiconductor Products Business” and  Note 4, “Discontinued Operations of Our Semiconductor Test Solutions Business” to our consolidated financial statements for further information. With this reorganization, Agilent has two businesses — bio-analytical measurement and electronic measurement. In addition to the discussion below, also see Note 23, “Segment Information”, to our consolidated financial statements.

 

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Electronic Measurement

 

Our electronic measurement business provides standard and customized solutions that are used in the design, development, manufacture, installation, deployment and operation of electronic equipment and systems and communications networks and services.

 

Orders and Net Revenue

 

		Years Ended October 31,									2006 over 2005		2005 over 2004
		2006			2005			2004			Change		Change
		(in millions)
Orders		$	3,336		$	3,184		$	3,069		5	%	4	%
Net revenue from products		$	2,797		$	2,661		$	2,648		5	%	—
Net revenue from services and other		505			507			473			—		7	%
Total net revenue		$	3,302		$	3,168		$	3,121		4	%	2	%

 

The order and revenue information below reflects a characterization using a new methodology for defining “communications test” and “general purpose test” as the markets into which our products are sold. This is a change from our previous classification method which relied on product type as the primary classification mechanism.

 

Compared to 2005, electronic measurement experienced a 5 percent increase in orders. Order growth was driven by strength in electronic manufacturing test, wireless component test, and signal sources for both aerospace/defense and wireless communication applications. The 4 percent increase in orders in 2005 compared to 2004 was related to significant growth in our wireline communications test businesses while wireless communications test orders grew only slightly in that period.

 

Electronic measurement revenues were up 4 percent year-over-year in 2006 mainly attributable to increased volumes. Communications test made up approximately 42 percent of the electronic measurement revenues for the year, and wireless test made up approximately 83 percent of communications test. Communication test revenues were down 9 percent year-over-year, with a 23 percent year-over-year decline in wireline test and wireless test down 5 percent as compared to last year. The decline in wireline test was driven by weakness in the router test and network monitoring businesses, while growth in wireless design software and wireless R&D were offset by weakness in the wireless network monitoring market. General purpose test revenues grew 10 percent over 2005, with strength in semiconductor design and verification, aerospace/defense and consumer electronic manufacturing applications. In 2005 segment revenues increased 2 percent compared to 2004 due to the strength of our signal analyzers and signal generator-related products, telecom service provider network integration and next-generation IP services.

 

Looking forward to 2007, we anticipate revenue growth to be driven by opportunities tied to the continued development and deployment of multi-media (voice, data, audio, video) wireless services, proliferation of broadband and triple-play wireline offerings, expansion of the breadth of our product offerings, and growth in nanotechnology applications.

 

Gross Margin and Operating Margin

 

The following table shows the electronic measurement business’s margins, expenses and income from operations for 2006 versus 2005 and 2005 versus 2004.

 

		Years Ended  October 31,									2006 over 2005		2005 over 2004
		2006			2005			2004			Change		Change
Total gross margin		56		%	53		%	51		%	3 ppts		2 ppts
Operating margin		14		%	11		%	8		%	3 ppts		3 ppts
Research and development		$	449		$	440		$	416		2	%	6	%
Selling, general and administrative		$	955		$	908		$	923		5	%	(2	)%
Income from operations		$	453		$	334		$	250		36	%	34	%

 

Over the past three years, we have implemented cost reduction and restructuring plans to help lower our cost structure. Our electronic measurement business ended 2006 with approximately 11,490 employees, an increase of approximately 300 employees from one year ago. The increase in workforce has occurred primarily in lower cost geographies.

 

Gross margin for products and services increased 3 percentage points year-over-year in 2006. Gross margin for products and services increased 2 percentage points in 2005 compared to 2004. The improvement for all periods were driven by some volume increases and also by restructuring activities, material cost reductions, lower inventory charges and overall operational improvements.

 

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Operating margin increased 3 percentage points in 2006 compared to 2005, with improved gross margins driving almost all of the change. Operating margin increased 3 percentage points in 2005 compared to 2004, and was driven by savings in selling, general and administrative expenses offset by increases in research and development expenditure.

 

Income from Operations

 

Income from operations increased in 2006 by $119 million compared to 2005 on a revenue increase of $134 million. Restructuring through selective workforce reductions, reductions in our cost structure, improved material costs, lower inventory charges and overall operational improvements helped comparative operating results, with most of the improvement coming from better gross margins. In absolute dollars cost of sales was down 3 percent from 2005 while revenue increased by 4 percent over the same period.

 

Income from operations increased in 2005 by $84 million compared to 2004 on a revenue increase of $47 million. Restructuring through workforce reductions, reduction in our cost structure and discretionary spending controls helped comparative operating results.

 

Bio-analytical Measurement

 

Our bio-analytical measurement business provides application-focused solutions that include instruments, software, consumables and services that enable customers to identify, quantify and analyze the physical and biological properties of substances and products. Our seven key product categories include: microarrays, microfluidics, gas chromatography, liquid chromatography, mass spectrometry, software and informatics, and related consumables, reagents and services. The business continued to achieve solid growth in 2006, with orders growing by 9 percent and revenue by 10 percent, compared to 2005, and operating income up 19 percent. All seven key product categories contributed to the overall growth of the bio-analytical measurement segment. In 2005 sustained growth was recorded compared to 2004 with orders and net revenue increasing by 10 percent and 6 percent respectively and operating income up 4 percent.

 

Orders and Net Revenue

 

		Years Ended October 31,									2006 over 2005		2005 over 2004
		2006			2005			2004			Change		Change
		(in millions)
Orders		$	1,739		$	1,589		$	1,443		9	%	10	%
Net revenue from products		$	1,328		$	1,193		$	1,138		11	%	5	%
Net revenue from services and other		$	343		325			299			6	%	9	%
Total net revenue		$	1,671		$	1,518		$	1,437		10	%	6	%

 

Bio-analytical measurement business orders continued to grow, achieving record levels in 2006. In both 2005 and 2006, growth was achieved in all geographies, with the highest rates achieved in Asia and Europe. Results were consistent with our normal seasonal pattern and reflected strong demand across virtually all of our markets.

 

Chemical analysis orders, representing approximately 59 percent of bio- analytical measurement, grew 8 percent in 2006 compared to 2005. During the year, we continued to see strength from the food and environmental segments due to increased testing demands from new regulations enacted in Europe and Asia, particularly China and India. These regulatory changes led to strong demand for our gas chromatography, liquid chromatography and mass spectrometry solutions that are used for food and environmental testing. Also new products such as the triple quadrupole (“QQQ”) mass spectrometer which sell into these segments were well received. In addition, higher average oil prices for the year continue to drive demand for our instrumentation in the hydrocarbon processing and petrochemical industries. Chemical analysis orders grew 6 percent in 2005 compared to 2004 driven by demand for environmental testing solutions in Asia and strength in US Government spending relating to homeland security.

 

Life science orders, representing approximately 41 percent of bio- analytical measurement, grew 11 percent for the 2006 year compared to 2005. This double digit growth was aided by the broad and rapid acceptance of recently introduced products such as the 1200 rapid resolution liquid chromatograph, QQQ mass spectrometer, new liquid chromatography columns, and new microarrays. During the year, we saw strong demand from contract research organizations and generic drug manufacturers in Europe and Asia, which helped offset a mostly soft spending year for large pharmaceuticals in the Americas region. Life science orders grew 16 percent in 2005 compared to 2004 driven primarily by biotechnology and increased demand from generic drug manufacture.

 

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Revenues for the year grew 10 percent in 2006 compared to 2005. Both chemical analysis and life sciences had solid annual growth both finishing the year at 10 percent. Chemical analysis continues to see strong demand for our food and environmental testing solutions, which use instruments in the areas of liquid and gas chromatography and gas chromatography mass spectrometry. In life sciences, demand from contract research organizations and generic drug manufacturers for product such as microarrays, liquid and gas chromatography mass spectrometry products contributed to this segment’s growth. In 2005, chemical analysis grew 2 percent compared to 2004, with most of this growth driven by increasing environmental testing in Asia, while in life science; this segment grew 12 percent, as growth in this segment was driven by increased demand from generic drug manufacturers.

 

Looking forward to 2007, we anticipate order and revenue to grow from 2006 levels, with strength across both our chemical analysis and life science businesses. We anticipate growth to be driven by recently released products such as rapid resolution liquid chromatography, enhanced single quadrupole liquid chromatography/mass spectrometry, QQQ, mass spectrometer, and quadrupole time-of-flight (“QTOF”) mass spectrometry systems.

 

Gross Margin and Operating Margin

 

The following table shows the bio-analytical measurement business’s margins, expenses and income from operations for 2006 versus 2005, and 2005 versus 2004.

 

		Years Ended October 31,									2006 over 2005		2005 over 2004
		2006			2005			2004			Change		Change
Total gross margin		53		%	50		%	49		%	3 ppts		1 ppts
Operating margin		16		%	15		%	15		%	1 ppt		—
Research and development		$	157		$	147		$	127		7	%	16	%
Selling, general and administrative		$	456		$	396		$	360		15	%	10	%
Income from operations		$	266		$	223		$	215		19	%	4	%

 

Gross margin in 2006 from products and services increased 3 percentage points compared to the same period last year. The improvement in gross margin was driven by increased revenue, manufacturing overhead efficiencies, and a decrease in general infrastructure costs. Gross margins increased by 1 percentage points in 2005 compared with 2004 due to revenue growth, improved microarray production processes, and increased efficiencies in support delivery.

 

Research and development expenses in 2006 increased by 7 percent compared to the same period last year. This increase is due to continued investment in life sciences, increase in headcount from acquisitions, program spending to support our new product releases for this year, and higher general infrastructure costs. Research and development costs increased by 16 percent in 2005 compared to 2004 primarily due to investment to support new product introductions, acquisition activity and Life Science businesses.

 

Selling, general, and administrative expenses in 2006 increased 15 percent compared to the same period last year. This is due to higher employee-related costs, incremental headcount from acquisitions, product launch expense to support new product releases, and higher general infrastructure costs. Selling, general and administrative expenses increased by 10 percent in 2005 compared to 2004 primarily due to increased infrastructure costs and integration expenses to support acquisitions.

 

Operating margins increased by 1 percentage point in 2006 compared to 2005. This is due to higher revenues and operational efficiencies offsetting the higher investments we made in research and development and selling, general, and administrative to accommodate growth. In 2005, operating margins were flat compared to 2004, as we heavily invested in research and development and small headcount increases in selling, general, and administrative to support growth.

 

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Income from Operations

 

Income from operations increased 19 percent in 2006 compared to 2005 due to increased revenue and operational efficiencies that offset higher investments and higher general infrastructure costs that were made in research and development and selling, general, and administrative to support our growth. Operating income increased 4 percent in 2005 compared to 2004 due to increased revenue.

 

Discontinued Operations of Our Semiconductor Products Business

 

On December 1, 2005, we completed the divestiture of our semiconductor products business to Avago Technologies Ltd. (“Avago”). Under the terms of the Asset Purchase Agreement (“APA”), Agilent received approximately $2.6 billion in cash proceeds. For further information, see Note 3, “Discontinued Operations of our Semiconductor Products Business”, to our consolidated financial statements.

 

Discontinued operations results for our semiconductor products business for the past three years, including the gain from sale in the year ended October 31, 2006, are summarized in the table below. In the year ended October 31, 2005, the results include the camera module business, which was sold in February 2005.

 

		Years Ended October 31,
		2006			2005			2004
		(in millions)
Net revenue		$	141		$	1,796		$	2,021
Costs, expenses and other income (expense), net		133			1,564			1,779
Income from discontinued operations		8			232			242
Gain on sale of discontinued operations		1,816			—			—
Income from and gain on sale of discontinued operations before taxes		1,824			232			242
Provision for taxes		8			46			—
Income from and gain on sale of discontinued operations, net		$	1,816		$	186		$	242

 

Discontinued Operations of Our Semiconductor Test Solutions Business

 

On August 15, 2005, Agilent announced its intention to separate its semiconductor test solutions business, Verigy, into a stand- alone publicly traded company. During the third quarter of fiscal 2006, Verigy completed the initial public offering (“IPO”) of 8.7 million of its ordinary shares at a price of $15 per share for total net proceeds of $121 million. As part of the offering, Agilent made a payment to Verigy of $19 million, the amount by which the net IPO proceeds were insufficient to complete the agreed-upon Verigy initial capitalization of $140 million. As a result of the IPO, Agilent recorded additional paid-in capital of $74 million related to the excess of the IPO price over the book value of the shares sold. Following the offering, Agilent owned 50 million shares or approximately 85 percent of Verigy’s ordinary shares.

 

On October 31, 2006, Agilent completed the spin-off of Verigy by distributing its remaining 85 percent equity interest in Verigy to Agilent stockholders. The spin-off was effected by way of a pro rata non-cash dividend to Agilent stockholders, which reduced retained earnings by $310 million. In the distribution, Agilent distributed to its stockholders .122435 of an ordinary share of Verigy for each outstanding share of Agilent common stock owned as of close of market on October 16, 2006. In the aggregate, Agilent distributed 50 million Verigy ordinary shares to Agilent stockholders. Based on the closing price for Verigy ordinary shares on the NASDAQ Global Select Market on October 31, 2006 of $16.80 per share, the aggregate market value of the shares distributed in the distribution was $840 million. The historical results of Verigy have been reflected as discontinued operations in the consolidated financial statements for all periods presented. For further information, see Note 4, “Discontinued Operations of our Semiconductor Test Solutions Business”, to our consolidated financial statements.

 

The following table summarizes results from discontinued operations for the presented periods ended October 31 included in the consolidated statement of operations:

 

		Years Ended October 31,
		2006			2005			2004
		(in millions)
Net revenue		$	777		$	454		$	604
Costs and expenses		703			489			522
Income (loss) from discontinued operations		74			(35		)	82
Other income (expense), net		—			(2		)	—
Income (loss) from discontinued operations before taxes		74			(37		)	82
Provision for taxes		20			13			14
Net income (loss) from discontinued operations		$	54		$	(50	)	$	68

 

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Indemnifications

 

In connection with the divestitures of our semiconductor products and semiconductor test businesses in 2006, we have provided indemnities to Verigy and Avago against certain damages which they might incur related to the businesses of Agilent not transferred to them and other defined categories of liability. These new indemnity obligations are in addition to preexisting indemnities to Hewlett Packard in connection with our activities prior to our spin-off from HP; indemnities to our officers and directors for certain liabilities which they might incur as a result of their service to Agilent; and other indemnifications which are customary in our industry or provided for in local law in the U.S. and other jurisdictions in connection with our commercial operations. These indemnities are described in greater detail in Note 17, “Guarantees”, to our consolidated financial statements.

 

Financial Condition

 

Liquidity and Capital Resources

 

Our financial position remained strong at October 31, 2006, with cash and cash equivalents of $2,262 million as compared to $2,226 million at October 31, 2005.

 

Net Cash Provided by Operating Activities

 

We generated cash from continuing operations of $431 million in 2006 compared to $656 million in 2005.

 

We paid approximately $156 million in taxes during 2006 as compared to $75 million in 2005. The higher tax payments in 2006 were mostly associated with the U.S. tax liability created in 2005 for repatriation of earnings from our foreign subsidiaries of $970 million under the American Jobs Creation Act of 2004, and with the 2005 federal alternate minimum tax.

 

We also made higher disbursements for restructuring activities of $166 million during 2006, primarily in the form of severance payments, compared to $110 million during 2005. The restructuring payments were more than offset by proceeds from the real estate sales related to the consolidation of excess facilities as reported in the investing section below. We have also paid approximately $155 million during 2006 under our variable pay programs, as compared to approximately $83 million paid out during 2005.

 

In 2006, accounts receivable generated cash of $8 million versus cash generated of $47 million in 2005. Days sales outstanding was reduced to 47 days in 2006 as compared to 49 days in 2005. Though revenue increased by 6 percent year-over-year, decline in day’s sales outstanding reflects continuing improvement in receivables management. In 2006, accounts payable generated cash of $56 million versus cash generated of $19 million in 2005. Inventory used cash of $55 million in 2006 compared to $12 million generated in 2005. Inventory days on hand were 95 days in 2006 compared to 90 days in 2005.

 

We contributed $41 million to fund our U.S. defined benefit plan in 2006 and 2005, respectively. In 2006, we contributed $76 million to fund our international defined benefits plans, compared to $34 million in 2005. In 2006, total pension plan contributions were $117 million, or 56 percent more than in 2005. In 2007, we expect funding requirements for our various benefit plans to decrease to a total of approximately $39 million. Our annual contributions are highly dependent on the relative performance of our assets versus our projected liabilities, among other factors. As the value of our assets increases relative to our future projected obligations we will make smaller contributions to maintain our funded status. In 2006, we recorded an additional minimum pension liability for $112 million as several of our non-U.S. defined benefit retirement plans had accumulated benefit obligations in excess of the fair value of plan assets. The establishment of the additional minimum liability also resulted in a net long term deferred tax asset for $34 million.

 

Net cash provided by operating activities from discontinued operations related to semiconductor products business was $7 million during 2006 as compared to $256 million in 2005. We completed the sale of our semiconductor products business in December 2005.

 

Net cash provided by operating activities from discontinued operations related to semiconductor test solutions business was $196 million during 2006 as compared to $13 million used in 2005. We completed the spin-off of our semiconductor test solutions business in October 2006.

 

Net Cash Provided by (Used in) Investing Activities

 

Net cash provided by investing activities of continuing operations 2006 was $1,838 million compared to $159 million used in the same period in 2005.

 

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In December 2005, we completed the divestiture of our semiconductor products division for $2.5 billion net of transaction costs and taxes. In November 2005, we also completed the sale of our ownership in Lumileds to Philips for approximately $949 million, plus repayment of approximately $51 million of outstanding principal debt and accrued interest from Lumileds. Sale of ownership in Lumileds resulted in a gain of approximately $901 million.

 

Restricted cash, cash equivalents and investments, net, increased by $1,584 million in 2006 as compared to a $22 million increase in 2005. In connection with the financing described under “Net Cash Provided by (Used in) Financing Activities” below, Agilent Technologies (Cayco) Limited, a wholly owned subsidiary of Agilent Technologies World Trade, Inc. (“World Trade”), which is in turn a wholly owned subsidiary of Agilent, is required to hold short-term investments. These short-term investments have been disclosed as restricted cash and cash equivalents on our consolidated balance sheet.

 

Investments in property, plant and equipment were $185 million, an increase of $57 million from 2005. The increase in the capital expenditure was due to our site restructuring following the semiconductor products division divestiture and spin-off of our semiconductor test solutions business. Proceeds from sale of property, plant and equipment were $207 million in 2006 as compared to $54 million in 2005. During 2006, we sold our Palo Alto site and San Jose site for a total consideration of approximately $186.5 million. We also purchased minority interests in consolidated joint ventures for $104 million during 2006 which included primarily the remaining minority interest of 49 percent in Yokogawa Analytical Systems for $98 million. In addition, we invested $50 million in the acquisitions of businesses and intangible assets, net of cash in 2006 compared to $64 million in 2005. Proceeds from the sale of short-term investments were $25 million in 2006.

 

Net cash used in investing activities of discontinued operations related to our semiconductor products business was $6 million in 2006 as compared to cash used of $27 million during 2005. Net cash used in investing activities of discontinued operations related to our semiconductor test solutions business was $36 million in 2006 as compared to cash used of $14 million during 2005.

 

Net Cash Provided by (Used in) Financing Activities

 

Net cash used in financing activities in 2006 was $2,548 million compared to $780 million used in 2005.

 

Our board of directors authorized a stock repurchase program of up to $4.466 billion in 2005 and up to an additional $2 billion by the end of fiscal 2008. We completed $4.466 billion stock repurchase program in 2006. In addition we also repurchased our common stock for $56 million under the 2006 program. As of October 31, 2006, we have acquired approximately 127 million shares of our common stock under both programs. Proceeds from issuance of common stock under employee stock plans were $547 million and $198 million during 2006 and 2005, respectively. The increase in the proceeds was primarily due to the higher exercise rate of options as a result of a higher Agilent stock price and modifications to the terms of the options held by employees of our semiconductor products business. The modification effected the acceleration of vesting for all unvested options as part of the divestiture of the semiconductor products business.

 

We distributed $300 million upon separation of our semiconductor test solutions business (“Verigy”) on October 31, 2006. This amount was held by Verigy as of October 31, 2006. Agilent also made a payment of $19 million pursuant to master separation agreement, the amount by which the aggregate net proceeds from Verigy IPO were less than $140 million. For further details, see Note 4, “Discontinued operations of our semiconductor test solutions business”, to our consolidated financial statements.

 

In January 2006, World Trade entered into a Master Repurchase Agreement and related Confirmation (together, the “Repurchase Agreement”) with a counterparty pursuant to which World Trade sold to the counterparty 15,000 Class A preferred shares having an aggregate liquidation preference of $1.5 billion of its wholly owned subsidiary, which has its own assets and liabilities, and received $1.5 billion in cash. Pursuant to the Repurchase Agreement, World Trade is obligated to repurchase from the counterparty the preferred shares for 100 percent of their aggregate liquidation preference in January 2011. The $1.5 billion obligation of World Trade to repurchase the preferred shares has been treated as long-term debt on our consolidated balance sheet.

 

In December 2005, we drew down $700 million on a $1 billion senior secured term borrowing facility to help finance our share repurchase program. In January 2006, we applied $700 million of the proceeds from the Repurchase Agreement to repay the full amount borrowed under the Credit Agreement. The senior secured term borrowing facility expired in the first quarter of 2006.

 

26

 

Net cash provided by financing activities of discontinued operations related to our semiconductor test solutions business was $140 million in 2006. During the third quarter of 2006, Verigy completed their initial public offering (“IPO”) of 8.7 million shares. In addition, the underwriters of the IPO exercised a portion of their over-allotment options. Total proceeds from IPO and exercise of over-allotment options by underwriters were $121 million, net. Agilent made a payment of an additional $19 million pursuant to master separation agreement, the amount by which the aggregate net proceeds from Verigy IPO were less than $140 million.

 

Other

 

We have contractual commitments for non-cancelable operating leases. See Note 18, “Commitments and Contingencies”, to our consolidated financial statements for further information on our non-cancelable operating leases.

 

Our liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and some of which arise from fluctuations related to global economics and markets. Our cash balances are generated and held in many locations throughout the world. Local government regulations may restrict our ability to move cash balances to meet cash needs under certain circumstances. We do not currently expect such regulations and restrictions to impact our ability to pay vendors and conduct operations throughout our global organization.

 

On April 13, 2005, Standard & Poor’s Rating Services (“S&P”) raised its corporate credit and senior unsecured debt ratings of Agilent to “BB+” from “BB”, revising their rating outlook to “stable” from “positive”. On August 15, 2005, S&P raised its rating outlook on Agilent to “positive”, but left the company’s corporate credit and senior unsecured debt ratings unchanged. On December 11, 2006, Moody’s Investors Service (“Moody’s”) upgraded their corporate family rating and probability of default rating of Agilent from “Ba2” to “Ba1” and revised their rating outlook to positive, leaving unchanged the speculative grade liquidity rating of “SGL-1”.

 

Contractual Commitments

 

Our cash flows from operations are dependent on a number of factors, including fluctuations in our operating results, accounts receivable collections, inventory management, and the timing of tax and other payments. As a result, the impact of contractual obligations on our liquidity and capital resources in future periods should be analyzed in conjunction with such factors.

 

The following table summarizes our total contractual obligations at October 31, 2006 for continuing operations and excludes amounts recorded in our consolidated balance sheet (in millions):

 

		Less than one year			One to three years			Three to five years			More than five years
Operating leases		$	79		$	106		$	41		$	37
Commitments to contract manufacturers and suppliers		426			—			—			—
Other purchase commitments		7			6			3			1
Retirement plans		39			—			—			—
Total		$	551		$	112		$	44		$	38

 

Operating leases. Commitments under operating leases relate primarily to leasehold property.

 

Commitments to contract manufacturers and suppliers. We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, we issue purchase orders with estimates of our requirements several months ahead of the delivery dates. However, our agreements with these suppliers usually allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. Typically purchase orders outstanding with delivery dates within 30 days are non-cancelable. Therefore, only approximately 36 percent of our reported purchase commitments arising from these agreements are firm, non-cancelable, and unconditional commitments. We expect to fulfill all purchase commitments for inventory within one year.

 

In addition to the above, we record a liability for firm, non-cancelable, and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with our policy relating to excess inventory. As of October 31, 2006, the liability for our firm, non-cancelable, and unconditional purchase commitments was $9 million, compared with $11 million as of October 31, 2005. These amounts are included in other accrued liabilities in our consolidated balance sheet.

 

Other purchase commitments. These relate primarily to contracts with professional services suppliers. Purchase commitments are typically cancelable within a 90-day period without significant penalties.

 

Retirement plans. Retirement plan funding includes the expected tax-deductible contribution planned for 2007. Funding projections beyond the current year are not practical to estimate due to the rules affecting tax deductible contributions and the impact from asset performance and interest rates.

 

We had no material off-balance sheet arrangements as of October 31, 2006 or October 31, 2005.

 

27

 

 

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL SCHEDULE

 

		Page
Item 8. Financial Statements and Supplementary Data		29
Management’s Report on Internal Control over Financial Reporting		29
Report of Independent Registered Public Accounting Firm		30
Consolidated Financial Statements of Agilent Technologies, Inc.:		31
Consolidated Statements of Operations for each of the three years ended October 31, 2006		31
Consolidated Balance Sheets at October 31, 2006 and October 31, 2005		32
Consolidated Statement of Cash Flows for each of the three years ended October 31, 2006		33
Consolidated Statement of Stockholders’ Equity for each of the three years ended October 31, 2006		34
Notes to Consolidated Financial Statements		35
Quarterly Summary (Unaudited)		68
Item 15. Exhibits and Financial Schedules		70
Financial Statement Schedule:		70
Schedule II - Valuation and Qualifying Accounts		71

 

28

 

Item 8. Financial Statements and Supplementary Data

 

Management's Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the results of this evaluation, our management concluded that our internal control over financial reporting was effective as of October 31, 2006.

 

Our management's assessment of the effectiveness of our internal control over financial reporting as of October 31, 2006 has been audited by PricewaterhouseCoopers LLP. an independent registered public accounting firm, as stated in their report which appears in Item 8 of this Current Report on Form 8-K.

 

29

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Stockholders and Board of Directors of Agilent Technologies, Inc.:

 

We have completed integrated audits of Agilent Technologies, Inc.’s 2006 and 2005 consolidated financial statements and of its internal control over financial reporting as of October 31, 2006, and an audit of its 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated financial statements and financial statement schedule

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Agilent Technologies, Inc. and its subsidiaries at October 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2006 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” as of November 1, 2005 and changed the manner in which it accounts for share-based compensation in fiscal 2006.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that the Company maintained effective internal control over financial reporting as of October 31, 2006 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

PRICEWATERHOUSECOOPERS LLP

 

San Jose, California

December 22, 2006, except with respect to our opinion on the consolidated financial statements, insofar as it relates to segment information in Note 23, as to which the date is October 11, 2007

 

30

 

AGILENT TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

 

		Years Ended October 31,
		2006			2005			2004
		(in millions, except per share data)
Net revenue:
Products		$	4,125		$	3,854		$	3,783
Services and other		848			831			773
Total net revenue		4,973			4,685			4,556
Costs and expenses:
Cost of products		1,799			1,817			1,939
Cost of services and other		516			504			453
Total costs		2,315			2,321			2,392
Research and development		655			650			599
Selling, general and administrative		1,660			1,498			1,502
Gain on sale of Palo Alto and San Jose site		(121		)	—			—
Total costs and expenses		4,509			4,469			4,493
Income from operations		464			216			63
Other income (expense), net		163			75			24
Income from continuing operations before taxes and equity income		627			291			87
Provision for income taxes		91			142			57
Equity in net income of unconsolidated affiliate (including gain) — Lumileds		901			42			29
Income from continuing operations		1,437			191			59
Income from and gain on sale of discontinued operations of our semiconductor products business (net of tax expense of $8 million in 2006, $46 million in 2005, and zero million in 2004)		1,816			186			242
Income (loss) from discontinued operations of our semiconductor test solutions business (net of tax expense of $20 million in 2006, $13 million in 2005, and $14 million in 2004)		54			(50		)	68
Net income		$	3,307		$	327		$	369
Net income (loss) per share — Basic:
Income from continuing operations		$	3.33		$	0.38		$	0.12
Income from and gain on sale of discontinued operations of our semiconductor products business, net		4.21			0.38			0.50
Income (loss) from discontinued operations of our semiconductor test solutions business, net		0.13			(0.10		)	0.14
Net income per share — Basic		$	7.67		$	0.66		$	0.76
Net income (loss) per share — Diluted:
Income from continuing operations		$	3.26		$	0.38		$	0.12
Income from and gain on sale of discontinued operations of our semiconductor products business, net		4.12			0.37			0.49
Income (loss) from discontinued operations of our semiconductor test solutions business, net		0.12			(0.10		)	0.14
Net income per share — Diluted		$	7.50		$	0.65		$	0.75
Weighted average shares used in computing net income (loss) per share:
Basic		431			494			483
Diluted		441			500			490

 

The accompanying notes are an integral part of these consolidated financial statements.

 

31

 

AGILENT TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEET

 

		October 31,
		2006			2005
		(in millions, except par value and share data)
ASSETS
Current assets:
Cash and cash equivalents		$	2,262		$	2,226
Short term investments		—			25
Accounts receivable, net		692			678
Inventory		627			612
Other current assets		377			288
Current assets of discontinued operations, semiconductor products business		—			423
Current assets of discontinued operations, semiconductor test solutions business		—			195
Total current assets		3,958			4,447
Property, plant and equipment, net		775			855
Goodwill and other intangible assets, net		468			345
Restricted cash and cash equivalents		1,606			22
Other assets		562			611
Non-current assets of discontinued operations, semiconductor products business		—			419
Non-current assets of discontinued operations, semiconductor test solutions business		—			52
Total assets		$	7,369		$	6,751
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	378		$	323
Employee compensation and benefits		414			522
Deferred revenue		225			205
Income and other taxes payable		390			474
Other accrued liabilities		131			158
Current liabilities of discontinued operations, semiconductor products business		—			150
Current liabilities of discontinued operations, semiconductor test solutions business		—			104
Total current liabilities		1,538			1,936
Long-term debt		1,500			—
Retirement and post-retirement benefits		288			381
Other long-term liabilities		395			341
Other long-term liabilities of discontinued operations, semiconductor test solutions business		—			12
Total liabilities		3,721			2,670
Commitments and contingencies (Note 18)
Stockholders’ equity:
Preferred stock; $0.01 par value; 125 million shares authorized; none issued and outstanding		—			—
Common stock; $0.01 par value; 2 billion shares authorized; 535 million shares at October 31, 2006 and 512 million shares at October 31, 2005 issued		5			5
Treasury stock at cost; 127 million shares at October 31, 2006 and 9 million shares at October 31, 2005		(4,525		)	(290		)
Additional paid-in-capital		6,605			5,878
Retained earnings (accumulated deficit)		1,534			(1,463		)
Accumulated other comprehensive income (loss)		29			(49		)
Total stockholders’ equity		3,648			4,081
Total liabilities and stockholders’ equity		$	7,369		$	6,751

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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AGILENT TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

 

		Years Ended October 31,
		2006			2005			2004
		(in millions)
Cash flows from operating activities:
Net income		$	3,307		$	327		$	369
Less: income from and gain on sale of discontinued operations of our semiconductor products business, net		1,816			186			242
Less: income (loss) from discontinued operations of our semiconductor test solutions business, net		54			(50		)	68
Income from continuing operations		1,437			191			59
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
Depreciation and amortization		170			180			212
Deferred taxes		(19		)	(12		)	(53		)
Excess and obsolete inventory-related charges		38			59			16
Non-cash restructuring and asset impairment charges		40			26			34
Net gain on sale of investments		(11		)	(8		)	—
Gain on sale and undistributed equity in net income of Lumileds		(901		)	(42		)	(29		)
Net gain on sale of assets and divestitures		(114		)	(18		)	—
Share-based compensation		94			8			7
Net pension curtailment and settlement gains		(23		)	—			—
Other		5			8			—
Changes in assets and liabilities:
Accounts receivable		8			47			35
Inventory		(55		)	12			13
Accounts payable		56			19			49
Employee compensation and benefits		(101		)	17			25
Income taxes and other taxes payable		(72		)	122			(50		)
Other current assets and liabilities		(70		)	(24		)	(33		)
Other long-term assets and liabilities		(51		)	71			22
Net cash provided by operating activities of continuing operations		431			656			307
Net cash provided by operating activities of discontinued operations related to our semiconductor products business		7			256			238
Net cash provided by (used in) operating activities of discontinued operations related to our semiconductor test solution business		196			(13		)	125
Net cash provided by operating activities		634			899			670
Cash flows from investing activities:
Investments in property, plant and equipment		(185		)	(128		)	(79		)
Proceeds from the sale of property, plant and equipment		207			54			34
Investments in equity securities		(5		)	(10		)	(14		)
Proceeds from the sale of Lumileds and other investments		974			22			—
Proceeds from divestitures		—			8			—
Net proceeds from sale of discontinued operations		2,510			—			—
Increase in restricted cash, cash equivalents and investments, net		(1,584		)	(22		)	—
Payment of loan receivable		50			6			—
Proceeds (purchases) of short-term investments, net		25			(25		)	—
Purchase of minority interest, primarily Yokogawa Analytical Systems		(104		)	—			—
Acquisitions of businesses and intangible assets, net of cash acquired		(50		)	(64		)	(18		)
Net cash provided by (used in) investing activities of continuing operations		1,838			(159		)	(77		)
Net cash used in investing activities of discontinued operations related to our semiconductor products business		(6		)	(27		)	(32		)
Net cash used in investing activities of discontinued operations related to our semiconductor test solutions business		(36		)	(14		)	(5		)
Net cash provided by (used in) investing activities		1,796			(200		)	(114		)
Cash flows from financing activities:
Issuance of common stock under employee stock plans		547			198			137
Treasury stock repurchases		(4,235		)	(290		)	—
Distribution on spin-off of subsidiary (our semiconductor test solutions business)		(300		)	—			—
Redemption of convertible debentures, net		—			(684		)	—
Capital contributions to subsidiary (our semiconductor test solutions business)		(19		)	—			—
Proceeds from term facility		700			—			—
Repayment of term facility		(700		)	—			—
Debt issuance costs		(25		)	—			—
Cash distribution to minority interest in consolidated joint venture		(16		)	—			—
Long term debt		1,500			—			—
Net payments (borrowings) related to notes payable and short-term borrowings		—			(4		)	1
Net cash provided by (used in) financing activities of continuing operations		(2,548		)	(780		)	138
Net cash provided by financing activities of discontinued operations related to our semiconductor test solutions business		140			—			—
Net cash provided by (used in) financing activities		(2,408		)	(780		)	138
Effect of exchange rate movements		14			(8		)	14
Net increase (decrease) in cash and cash equivalents		36			(89		)	708
Cash and cash equivalents at beginning of year		2,226			2,315			1,607
Cash and cash equivalents at end of year		$	2,262		$	2,226		$	2,315

 

The accompanying notes are an integral part of these consolidated financial statements.

 

33