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 Annual Report on Form 10-K. This report contains forward-looking statements including, without limitation, statements regarding trends, seasonality and growth in, and drivers of, the markets we sell into, our strategic direction, new product and service introductions and future products and services, adoption of our products, the ability of our products to meet market and customer needs, improving our customers’ experience, future financial results, our operating margin, mix, our investments, including in manufacturing infrastructure and research and development, our ability to identify and enable synergies across our businesses, our focus on balanced capital allocation, competition, our contributions to our pension and other defined benefit plans, impairment of goodwill and other intangible assets, the effect of the U.S. Tax Cuts and Jobs Act of 2017 and U.S. and other tariffs, the impact of foreign currency movements, our hedging programs and other actions to offset the effects of tariffs and foreign currency movements, our future effective tax rate and tax valuation allowance, earnings from our foreign subsidiaries, repatriation of our earnings from foreign jurisdictions, the impact of local government regulations on our ability to pay vendors or conduct operations, our liquidity position, our ability to generate cash from operations, the potential impact of adopting new accounting pronouncements,indemnification, the use of contract manufacturers, out sourcing and third-party package delivery services, source and supply of materials used in our products, our sales, our purchase commitments, our capital expenditures, the integration of our acquisitions and other transactions, write down of investment values or loans and convertible notes, our stock repurchase program, our declared dividends, and the existence of economic instability, 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 Part I Item 1A and elsewhere in this Form 10-K.

Overview and Executive Summary

Agilent Technologies Inc. ("we", "Agilent" or the "company"), incorporated in Delaware in May 1999, is a global leader in life sciences, diagnostics and applied chemical markets, providing application focused solutions that include instruments, software, services and consumables for the entire laboratory workflow.

In 2018, we acquired seven businesses for a combined purchase price of approximately $536 million. The largest of which was Advanced Analytical Technologies, Inc. ("AATI") for approximately $268 million in cash. On November 14, 2018, we acquired 100 percent of the stock of ACEA Biosciences Inc. ("ACEA"), a developer of cell analysis tools, for $250 million in cash. The financial results of ACEA will be included within our financial results from the date of the close. In 2017, we acquired two businesses for a combined purchase price of approximately $125 million in cash.

Agilent's net revenue of $4,914 million in 2018 increased 10 percent when compared to 2017 . Foreign currency movements for 2018 had an overall favorable impact on revenue of approximately 2  percentage points compared to 2017 . Acquisitions in 2018 had an overall favorable impact of 1 percentage point when compared to 2017 . Revenue in the life sciences and applied markets business increased 9 percent in 2018 when compared to 2017 . Foreign currency movements had an favorable impact on revenue of 2 percentage points in 2018 when compared to 2017 . Revenue in the diagnostics and genomics business increased 10 percent in 2018 when compared to 2017 . Foreign currency movements had an favorable impact on revenue of 3 percentage points in 2018 when compared to 2017 . Revenue in the Agilent CrossLab business increased 11 percent in 2018 when compared to 2017 . Foreign currency movements had an favorable impact on revenue of 2 percentage points in 2018 when compared to 2017 .

Agilent's net revenue of $4,472 million increased 6 percent in 2017 when compared to 2016 . Foreign currency movements for 2017 had an overall unfavorable impact on revenue of approximately 1  percentage point compared to 2016 . Revenue in the life sciences and applied markets business increased 4 percent in 2017 when compared to 2016 . Foreign currency movements had an overall unfavorable impact on revenue of less than 1 percentage point in 2017 when compared to 2016 . Revenue in the diagnostics and genomics business increased 9 percent in 2017 when compared to 2016 . Foreign currency movements had no overall impact on revenue in 2017 when compared to 2016 . Revenue in the Agilent CrossLab business increased 8 percent in 2017 when compared to 2016 . Foreign currency movements had an overall unfavorable impact on revenue of less than 1 percentage point in 2017 when compared to 2016 .

Net income was $316 million in 2018 compared to net income of $684 million and $462 million in 2017 and 2016 , respectively. Net income for the year ended October 31, 2018 was impacted by a discrete tax charge of $552 million related to the enactment of the Tax Act passed on December 22, 2017. See Note 4, "Income Taxes" for more details. As of October 31, 2018 and 2017 , we had cash and cash equivalents balances of $2,247 million and $2,678 million , respectively.

On November 22, 2013 we announced that our board of directors had authorized a share repurchase program. The program was designed to reduce or eliminate dilution resulting from issuance of stock under the company's employee equity incentive

programs to target maintaining a weighted average share count of approximately 335 million diluted shares. For the year ended October 31, 2016 we repurchased 2 million shares for $98 million which completed the purchases under this authorization.

On May 28, 2015 we announced that our board of directors had approved a new share repurchase program (the "2015 repurchase program"). The 2015 share repurchase program authorizes the purchase of up to $1.14 billion of our common stock at the company's discretion through and including November 1, 2018. The 2015 repurchase program does not require the company to acquire a specific number of shares and may be suspended or discontinued at any time. During the year ended October 31, 2016 , upon the completion of our previous repurchase program, we repurchased approximately 8.3 million shares for $336 million under this authorization. During the year ended October 31, 2017 , we repurchased approximately 4.1 million shares for $194 million under this authorization. During the year ended October 31, 2018 we repurchased and retired approximately 6.4 million shares for $422 million under this authorization. As of October 31, 2018 , we had remaining authorization to repurchase up to $188 million of our common stock under this program which expired on November 1, 2018.

On November 19, 2018 we announced that our board of directors had approved a new share repurchase program (the "2019 repurchase program") designed, among other things, to reduce or eliminate dilution resulting from issuance of stock under the company's employee equity incentive programs. The 2019 share repurchase program authorizes the purchase of up to $1.75 billion of our common stock at the company's discretion and has no fixed termination date. The 2019 repurchase program does not require the company to acquire a specific number of shares and may be suspended, amended or discontinued at any time.

During the year ended October 31, 2018 , cash dividends of $0.596 per share, or $191 million were declared and paid on the company's outstanding common stock. During the year ended October 31, 2017 , cash dividends of $0.528 per share, or $170 million were declared and paid on the company's outstanding common stock. During the year ended October 31, 2016 , cash dividends of $0.460 per share, or $150 million were declared and paid on the company's outstanding common stock.

On November 14, 2018 we declared a quarterly dividend of $0.164 per share of common stock, or approximately $52 million which will be paid on January 23, 2019 to shareholders of record as of the close of business on December 31, 2018 . The timing and amounts of any future dividends are subject to determination and approval by our board of directors.

Looking forward, we continue to focus on differentiating product solutions, improving our customers' experience and growing our operating margin. In addition, we remain focused on a balanced capital allocation through our dividend and share repurchase programs. We expect foreign currency to negatively impact revenue in 2019 but we also anticipate the contribution from our recent acquisitions to partially offset the currency impact.

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. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. 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, inventory valuation, share-based compensation, retirement and post-retirement plan assumptions, valuation of goodwill and purchased intangible 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 collectability 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. We allocate revenue to each element in our multiple-element arrangements based upon their relative selling prices. We determine the selling price for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on our vendor specific objective evidence (VSOE) if available, third-party

evidence (TPE) if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. Revenue from the sale of software products that are not required to deliver the tangible product's essential functionality are accounted for under software revenue recognition rules. Revenue allocated to each element is then recognized when the basic revenue recognition criteria for that element have been met. The amount of product revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements.

The aforementioned factors may result in a different allocation of revenue to the deliverables in multiple element arrangements, which may change the pattern and timing of revenue recognition for these elements but will not change the total revenue recognized for the arrangement.

Inventory Valuation.     We assess the valuation of our inventory on a periodic basis and make adjustments to 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 excess inventory review process includes analysis of 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.

Share-Based Compensation.     We account for share-based awards in accordance with the authoritative guidance. Under the authoritative guidance, share-based compensation expense is primarily based on estimated grant date fair value and is recognized on a straight-line basis. The fair value of share-based awards for employee stock option awards was estimated using the Black-Scholes option pricing model. Stock options were granted in years prior to fiscal year 2016. Shares granted under the Long-Term Performance Program based on Total Shareholders Return ("LTPP-TSR") were valued using the Monte Carlo simulation model. The estimated fair value of restricted stock unit awards, LTPP based on Operating Margin (“LTPP-OM”) and LTPP based on Earnings per share (“LTPP-EPS”) is determined based on the market price of Agilent's common stock on the date of grant adjusted for expected dividend yield. The compensation cost for LTPP (OM) and LTPP (EPS) reflects the cost of awards that are probable to vest at the end of the performance period. In the case of LTPP-OM, the performance targets for all the three years of performance period is set at the time of grant. The performance targets for LTPP-EPS grants for year 2 and year 3 of the performance period will be set in the first quarter of year 2 and year 3, respectively. The probable shares to vest are estimated based on the forecasted OM and EPS at the time of the grant and updated every quarter with latest forecast and actual information. The Employee Stock Purchase Plan ("ESPP") allows eligible employees to purchase shares of our common stock at 85 percent of the fair market value at the purchase date. All awards granted after 2015 to our senior management employees have a one year post-vest holding restriction. The estimated discount associated with post-vest holding restrictions is calculated using the Finnerty model.

Both the Black-Scholes and Monte Carlo simulation fair value models require the use of highly subjective and complex assumptions, including the option's expected life and the price volatility of the underlying stock. For LTPP (TSR) grants in 2016, we used the 3-year average historical stock price volatility of a group of our peer companies. We believed our historical volatility prior to the separation of Keysight in 2015 was no longer relevant to use. For the 2017 and 2018 LTPP (TSR) grants and calculation of the post-vest discount using the Finnerty model, we used our own post-separation historical stock price volatility. See Note 3, "Share-based Compensation," to the consolidated financial statements for more information.

 

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, 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 both U.S. and non-U.S. plans. For 2018 and 2017 , the U.S. discount rates were based on the results of matching expected plan benefit payments with cash flows from a hypothetically constructed bond portfolio. In 2018 , discount rates for the U.S. plans

increased compared to the previous year. For 2018 and 2017 , the discount rate for non-U.S. plans was generally based on published rates for high quality corporate bonds and in 2018 , slightly increased compared to the previous year. If we changed our discount rate by 1 percent, the impact would be less than $1 million in U.S. pension expense and $16 million on non-U.S. pension expense. Lower discount rates increase present values of the pension benefit obligation and subsequent year pension expense; higher discount rates decrease present values of the pension benefit obligation and subsequent year pension expense.

The company uses alternate methods of amortization as allowed by the authoritative guidance which amortizes the actuarial gains and losses on a consistent basis for the years presented. For U.S. Plans, gains and losses are amortized over the average future lifetime of participants using the corridor method. For most Non-U.S. Plans and U.S. Post-Retirement Benefit Plans, gains and losses are amortized using a separate layer for each year's gains and losses. The expected long-term return on plan assets is estimated using current and expected asset allocations as well as historical and expected returns. Plan assets are valued at fair value. If we changed our estimated return on assets by 1 percent , the impact would be $4 million on U.S. pension expense and $9 million on non-U.S. pension expense. For 2018 , actual return on assets was below expectations which, along with contributions during the year, increased next year’s pension cost as well as resulting in a decrease of the funded status at year end. The net periodic pension and post-retirement benefit costs recorded were a $3 million benefit in 2018 , $15 million benefit in 2017 and $3 million expense in 2016. The years ended October 31, 2018 , 2017 and 2016, included a gain on curtailment and settlements of $5 million, $32 million and $16 million, respectively.

Goodwill and Purchased Intangible Assets. Under the authoritative guidance, we have the option to perform a qualitative assessment to determine whether further impairment testing is necessary. The accounting standard gives an entity the option to first assess qualitative factors to determine whether performing the two-step test is necessary. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not (i.e. greater than 50% chance) that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test will be required. Otherwise, no further testing will be required.

The guidance includes examples of events and circumstances that might indicate that a reporting unit's fair value is less than its carrying amount. These include macro-economic conditions such as deterioration in the entity's operating environment or industry or market considerations; entity-specific events such as increasing costs, declining financial performance, or loss of key personnel; or other events such as an expectation that a reporting unit will be sold or a sustained decrease in the stock price on either an absolute basis or relative to peers.

If it is determined, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the provisions of authoritative guidance require that we perform a two-step impairment test on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. The second step (if necessary) measures the amount of impairment by applying fair-value-based tests to the individual assets and liabilities within each reporting unit. As defined in the authoritative guidance, a reporting unit is an operating segment, or one level below an operating segment. We aggregate components of an operating segment that have similar economic characteristics into our reporting units.

In fiscal year 2018 , we assessed goodwill impairment for our three reporting units which consisted of three segments: life sciences and applied markets, diagnostics and genomics and Agilent CrossLab. We performed a qualitative test for goodwill impairment of the three reporting units, as of September 30, 2018 . Based on the results of our qualitative testing, we believe that it is more-likely-than-not that the fair value of these reporting units are greater than their respective carrying values. Each quarter we review the events and circumstances to determine if goodwill impairment is indicated. There was no impairment of goodwill during the years ended October 31, 2018 , 2017 and 2016 .

Purchased intangible assets consist primarily of acquired developed technologies, proprietary know-how, trademarks, and customer relationships and are amortized using the best estimate of the asset's useful life that reflect the pattern in which the economic benefits are consumed or used up or a straight-line method ranging from 6 months to 15 years. In-process research and development ("IPR&D") is initially capitalized at fair value as an intangible asset with an indefinite life and assessed for impairment thereafter. When the IPR&D project is complete, it is reclassified as an amortizable purchased intangible asset and is amortized over its estimated useful life. If an IPR&D project is abandoned, we will record a charge for the value of the related intangible asset to our consolidated statement of operations in the period it is abandoned.

We continually monitor events and changes in circumstances that could indicate carrying amounts of finite-lived intangible assets may not be recoverable. When such events or changes in circumstances occur, we assess the recoverability of finite-lived intangible assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the undiscounted future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. During 2018, we recorded an impairment charge of $21 million related to purchased intangible assets within the diagnostics and genomics segment that were deemed unrecoverable.

Our indefinite-lived intangible assets are IPR&D intangible assets. The accounting guidance allows a qualitative approach for testing indefinite-lived intangible assets for impairment, similar to the issued impairment testing guidance for goodwill and allows the option to first assess qualitative factors (events and circumstances) that could have affected the significant inputs used in determining the fair value of the indefinite-lived intangible asset to determine whether it is more-likely-than-not (i.e. greater than 50% chance) that the indefinite-lived intangible asset is impaired. An organization may choose to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to calculating its fair value. We performed a qualitative test for impairment of indefinite-lived intangible assets as of September 30, 2018 . Based on the results of our qualitative testing, we believe that it is more-likely-than-not that the fair value of these indefinite-lived intangible assets is greater than their respective carrying values. Each quarter we review the events and circumstances to determine if impairment of indefinite-lived intangible asset is indicated. During the years ended October 31, 2018 and 2017 , there were no impairments of indefinite-lived intangible assets. Based on triggering events in the year ended October 31, 2016 , we recorded an impairment of $4 million due to the cancellation of certain IPR&D projects.

Accounting for Income Taxes. We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits and deductions, and in the calculation of certain tax assets and liabilities which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period. On a quarterly basis, we provide for income taxes based upon an estimated annual effective tax rate. The effective tax rate is highly dependent upon the geographic composition of worldwide earnings, tax regulations governing each region, availability of tax credits and the effectiveness of our tax planning strategies. We monitor the changes in many factors and adjust our effective income tax rate on a timely basis. If actual results differ from these estimates, this could have a material effect on our financial condition and results of operations.

Significant management judgment is also required 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 deferred tax assets may not be realized, a valuation allowance must be established against such deferred tax assets. We consider all available positive and negative evidence on a jurisdiction-by-jurisdiction basis when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of losses in recent years and our forecast of future taxable income. At October 31, 2018, we continue to recognize a valuation allowance for certain U.S. and U.S state and foreign deferred tax assets. We intend to maintain a valuation allowance in these jurisdictions until sufficient positive evidence exists to support its reversal.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax law and regulations in a multitude of jurisdictions. Although the guidance on the accounting for uncertainty in income taxes prescribes the use of a recognition and measurement model, the determination of whether an uncertain tax position has met those thresholds will continue to require significant judgment by management. In accordance with the guidance on the accounting for uncertainty in income taxes, 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. The ultimate resolution of tax uncertainties may differ from what is currently estimated, which could result in a material impact on income tax expense. 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. We include interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of operations.

On December 22, 2017, the Tax Act was enacted into law. The Tax Act significantly changes the existing U.S. tax law and includes numerous provisions that affect our business. ASC 740, Income Taxes, requires companies to recognize the effect of the tax law changes in the period of enactment. However, the SEC staff issued Staff Accounting Bulletin 118 which allowed companies to record provisional amounts during a measurement period that should not extend beyond one year from the Tax Act enactment date. We have recognized the tax charge of $499 million due to transition tax liability and $53 million due to the impact of reduction in U.S. tax rates in the period when the tax law was enacted as a component of provision for income taxes from continuing operations. We have completed the accounting for all the impacts of the Tax Act except for the policy election for the treatment of the tax on global intangible low-tax income (“GILTI”) inclusions. See Note 4, "Income Taxes" for more details. These computations are based on the regulations and guidance already provided by federal and state tax authorities. The company will continue to assess the impact of the further guidance from federal and state tax authorities on its business and consolidated financial statements. Any future adjustments will be recognized as discrete income tax expense or benefit in the period the adjustments are determined.

Adoption of New Pronouncements

See Note 2, "New Accounting Pronouncements," to the consolidated financial statements for a description of new accounting pronouncements.

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. The favorable effects of changes in foreign currency exchange rates has increased revenue by approximately 2 percentage point for the year ended October 31, 2018 . When movements in foreign currency exchange rates have a positive impact on revenue it will also have a negative impact on our costs and expenses. The unfavorable effects of changes in foreign currency exchange rates has decreased revenue by approximately 1 percentage point for the year ended October 31, 2017 . When movements in foreign currency exchange rates have a negative impact on revenue it will also have a positive impact on our costs and expenses. We calculate the impact of foreign currency exchange rates movements by applying the actual foreign currency exchange rates in effect during the last month of each quarter of the current year to both the applicable current and prior year periods. 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 (up to a rolling twelve-month period). Therefore, we are exposed to currency fluctuations over the longer term. To the extent that we are required to pay for all, or portions, of an acquisition price in foreign currencies, we may enter into foreign exchange contracts to reduce the risk that currency movements will impact the U.S. dollar cost of the transaction.