The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and our Annual Report on Form 10-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 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, our stock repurchase program, our transition to lower-cost regions, our planned restructuring activities, including our current estimates of the scope, timing and cost of those activities, the existence or length of an economic recovery that involve risks and uncertainties, and the impact of an Internal Revenue Service ("IRS") Revenue Agent's Report ("RAR") on our operations and financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to various factors, including those discussed below in "Risks, Uncertainties and Other Factors That May Affect Future Results" and elsewhere in this Form 10-Q.

Basis of Presentation

The financial information presented in this Form 10-Q is not audited and is not necessarily indicative of our future consolidated financial position, results of operations or cash flows. Our fiscal year-end is October 31, and our fiscal quarters end on January 31, April 30 and July 31. Unless otherwise stated, all dates refer to our fiscal year and fiscal periods.

Executive Summary

Agilent Technologies, Inc. ("we", "Agilent" or the "company") 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. Agilent has three primary businesses that are focused on the electronic measurement market, the semiconductor and board test market and the bio-analytical measurement market.

For the three months ended January 31, 2009 we experienced the adverse effects of the worldwide economic downturn on our overall performance. The deterioration of the global economy has affected all of our businesses with weakness in electronic measurement and semiconductor board and test markets and a slowing in demand in bio-analytical measurement markets.

Total orders for the three months ended January 31, 2009 were $1,115 million, a decrease of 20 percent from the same period last year with orders in each business segment down. For the three months ended January 31, 2009, bio-analytical orders decreased 2 percent, electronic measurement orders decreased 28 percent and semiconductor and board test orders decreased 66 percent when compared to the first quarter of 2008.

Net revenue of $1,166 million for the three months ended January 31, 2009 was down 16 percent from the same period last year. Bio-analytical revenues decreased 1 percent in the three months ended January 31, 2009 with both chemical analysis and life science down 1 percent compared to the same period last year. Geographically, weakness was most pronounced for bio-analytical in Europe with a decrease of 11 percent while the Americas increased 1 percent and Asia increased 10 percent in the three months ended January 31, 2009 compared to the same period last year. Electronic measurement revenues decreased 23 percent in the three months ended January 31, 2009 with both general purpose and communications test down 23 percent compared to the same period last year. Geographically, electronic measurement revenues for the three months ended January 31, 2009 decreased in Europe by 26 percent, in Asia by 29 percent and in Americas by 15 percent compared to the same period last year. Semiconductor and board test measurement revenues decreased 49 percent when compared to the first quarter of last year with all markets down compared to the same period last year. On a geographic basis, revenue declined 46 percent in the Americas, 68 percent in Europe and 39 percent in Asia.

Net income for the three months ended January 31, 2009 was $64 million, compared to $120 million for the corresponding period last year. In comparison to the same period last year, for the three months ended January 31, 2009, net income decreased due to reduced revenue. Tax expense decreased $64 million when compared to the first quarter of last year primarily due to net discrete tax benefits associated with lapses of statutes of limitations and tax settlements.

In the three months ended January 31, 2009, we generated $17 million of cash from operations compared with $4 million generated in the three months of the prior year. In November 2008, we terminated two swap agreements and received proceeds of $43 million, recorded in operating cash flows.

In December 2008, we announced a targeted operational restructuring plan (the "FY 2009 Plan") in response to the deteriorating economic conditions. As a result of this program, we expect that the global workforce of regular employees will be reduced by approximately 500 positions. In addition, we announced that we would eliminate 300 temporary positions. When completed, the restructuring program and reductions in temporary workforce are expected to result in future annual operating savings of approximately $65 million.

In February 2009, we announced an additional restructuring program that includes actions to exit the inspection businesses in our semiconductor and board test segment and to restructure our global infrastructure organization. When completed, the additional restructuring is expected to result in future annual operating savings of approximately $150 million. We expect workforce reductions of approximately 600 regular positions.

The December 2008 and February 2009 restructuring activities will be combined under a single restructuring plan and are part of a series of actions being taken by Agilent in response to the current economic situation. In connection with the combined restructuring plan, we expect to record in aggregate approximately $155 million in pre-tax restructuring and other charges related to business and infrastructure cost reduction. We expect that a significant proportion of these charges will result in cash expenditures.

Looking forward, we face continued challenging business conditions as the global economic environment deteriorates and the outlook is highly uncertain. We are committed to delivering performance consistent with Agilent's operating model.

Critical Accounting Policies and Estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with generally accepted accounting principles ("GAAP") in the U.S. The preparation of condensed consolidated financial statements in conformity with GAAP in the U.S. requires management to make estimates, judgments and assumptions that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. 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, investment impairments, share-based compensation, retirement and post-retirement benefit plan assumptions, restructuring and asset impairment charges, valuation of long-lived assets and accounting for income taxes. 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.

Share-based compensation. The expected stock price volatility assumption was determined using the historical volatility for our stock for the three months ended January 31, 2009. We estimate the stock price volatility using the historical volatility of Agilent's stock options over the most recent historical period equivalent to the expected life. In reaching this conclusion, we have considered many factors including the extent to which our options are currently traded and our ability to find traded options in the current market with similar terms and prices to the options we are valuing. A 10 percent increase in our estimated historical volatility from 32 percent to 42 percent would generally increase the value of an award and the associated compensation cost by approximately 24 percent if no other factors were changed.

Goodwill and purchased intangible assets. During the three months ended January 31, 2009, we tested certain intangible assets for impairment 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"), which resulted in an impairment of $10 million. We test goodwill for impairment annually (and more often frequently if impairment indicators arise). There was no impairment of goodwill during the three months ended January 31, 2009.

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 SFAS No. 144, Staff Accounting Bulletin 100, "Restructuring and Impairment Charges" ("SAB 100") and 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.

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.

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 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. 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 cumulative losses in recent years and our forecast of future taxable income. At January 31, 2009, we provided partial valuation allowances for our U.S. deferred tax assets and full or partial valuation allowances on certain foreign deferred tax assets. We intend to maintain partial or full valuation allowances until sufficient positive evidence exists to support reversal of a valuation allowance in a given taxing jurisdiction.

We have not provided for all U.S. federal income and foreign withholding taxes on the undistributed earnings of some 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. Although FASB Interpretation No. 48 provides further clarification on the accounting for uncertainty in income taxes, the threshold and measurement attributes prescribed by the pronouncement will continue to require significant judgment by management. If the ultimate resolution of tax uncertainties is different from what is currently estimated, a material impact on income tax expense could result.

Adoption of New Pronouncements

See Note 3, "New Accounting Pronouncements," to the condensed consolidated financial statements for a description of new accounting pronouncements.

Restructuring Costs, Asset Impairments and Other Charges

In December 2008, we announced the FY 2009 Plan. Initially, we expected to reduce our annual operating expenses by reducing approximately 500 positions of the global workforce of regular employees. In February 2009, we announced we had expanded the FY 2009 Plan to include actions to exit the inspection businesses in our semiconductor and board test segment and to restructure our global infrastructure organization. Under the FY 2009 Plan, we expect to record in aggregate approximately $155 million in pre-tax restructuring and other charges related to business and infrastructure cost reduction. We expect that a significant proportion of these charges will result in cash expenditures. When completed, these actions together are expected to result in annual operating savings of approximately $215 million and workforce reductions of approximately 1,100 regular positions.

Total restructuring and other special charges of $48 million have been incurred in the first quarter of 2009 with respect to these actions, with a further charge of approximately $107 million expected for the rest of the year. Of the $48 million, $13 million related to asset impairments and $22 million related to special charges for excess inventory as a result of exiting the inspection businesses in our semiconductor and board test segment. Of the 1,100 regular positions, about 250 employees have been notified as of January 31, 2009.

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 condensed 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.

Results from Operations



Orders and Net Revenue



                       Three Months Ended
                          January 31,         2009 over
                        2009         2008       2008
                         (in millions)
Orders               $    1,115    $  1,401         (20 )%
Net revenue:
Products                    937       1,161         (19 )%
Services and other          229         232          (1 )%
Total net revenue    $    1,166    $  1,393         (16 )%

Agilent orders decreased 20 percent for the three months ended January 31, 2009 compared to the same period in 2008. Our bio-analytical measurement business saw signs of weakening market activity and recorded an order decrease of 2 percent for the three months ended January 31, 2009. In comparison with the same period last year, electronic measurement orders decreased 28 percent for the three months ended January 31, 2009 with weakness in both general purpose and communications test markets. The semiconductor and board test measurement orders decreased 66 percent for the three months ended January 31, 2009 with all markets and geographies down in comparison with the same period last year.

Agilent net revenue decreased 16 percent for the three months ended January 31, 2009 compared to the same period last year. The bio-analytical measurement business revenues decreased 1 percent for the three months ended January 31, 2009 with chemical analysis and life sciences both reporting a decrease of 1 percent when compared to the same period in the prior year. By product platform, both gas chromatography ("GC") and liquid chromatography ("LC") were weaker while both microarrays and liquid chromatography/mass spectrometry ("LC/MS") increased over the same period last year. Electronic measurement business revenues decreased 23 percent for the three months ended January 31, 2009 compared with the prior year. Both general purpose test and communications test end markets decreased 23 percent as market decline was widespread and demand from large multinationals was particularly weak. Semiconductor and board test measurement revenues decreased 49 percent when compared to the first quarter of last year with all markets down.

Services and other revenue include revenue generated from servicing our installed base of products, warranty extensions and consulting. Services and other revenue for the three months ended January 31, 2009 decreased 1 percent as compared to the same period last year. Service revenue trends tend to lag product revenue due to the deferral of service revenue, most of which is recognized over extended time periods.

Operating Results



                                          Three Months
                                        Ended January 31,     2009 over
                                         2009         2008      2008
Total gross margin                          50.5 %     54.3 %        (4 )ppts
Operating margin                             2.1 %      9.6 %        (8 )ppts

(in millions)
Research and development              $      169     $  181          (7 )%
Selling, general and administrative   $      396     $  441         (10 )%

Total gross margins for the three months ended January 31, 2009 showed a 4 percentage point decrease compared to the same period last year. The majority of the decrease in gross margins was volume related. Operating margins have decreased by 8 percentage points for the three months ended January 31, 2009 compared with the same period last year.

Research and development expenses decreased 7 percent for the three months ended January 31, 2009 compared to the same period last year. Approximately 4 percentage points of the decrease has been created by the relative movement in currencies over the prior year. We remain committed to invest in research and development by bringing new products to the market, and have focused our development efforts on key strategic opportunities in order to align our business with available markets and position ourselves to capture market share.

Selling, general and administrative expenses decreased 10 percent for the three months ended January 31, 2009 compared to the same period last year. Decrease in expenditures in the three months ended January 31, 2009 was due to control over expenses we have implemented in this difficult economic environment. The impact of currency movement decreased total selling, general and administrative expenses by 4 percent for the three months ended January 31, 2009.

At January 31, 2009, our headcount was approximately 19,340 as compared to approximately 19,410 at January 31, 2008.

Global Infrastructure Organization

Our global infrastructure organization ("GIO") remains a key component of our operating model. GIO, which includes IT, Workplace Services, HR, Legal and Finance, continues to work proactively to reduce expenses while delivering infrastructure support to business operations. In response to the continuing deterioration of economic conditions we have announced a GIO restructuring program in February 2009. This will move GIO to a more appropriate size and structure for the current economic realities.

Provision for Income Taxes

For the three months ended January 31, 2009, we recorded an income tax benefit of $37 million compared to an income tax provision of $27 million in the same period last year. The income tax benefit for the three months ended January 31, 2009 includes a net discrete benefit of tax and interest in the amount of $42 million. The net discrete benefit is primarily associated with lapses of statutes of limitations and tax settlements. The income tax benefit is net of taxes recorded for income generated in jurisdictions other than the Netherlands, Puerto Rico, Switzerland, the U.S. and the U.K. where we have recorded valuation allowances. We intend to maintain partial or full valuation allowances in these jurisdictions until sufficient positive evidence exists to support the reversal of the valuation allowances.

At January 31, 2009, our estimate of the annual effective tax rate was 13 percent on continuing operations. The income tax rate for continuing operations was (137) percent for the three months ended January 31, 2009. Excluding the impact of net discrete tax benefits, we anticipated at January 31, 2009 that the full-year 2009 effective tax rate on continuing operations would be approximately 18 percent. Given uncertain economic times, it is likely that the effective tax rate will change as the amount and/or mix of income and related taxes changes. The full-year tax rate reflects taxes in all jurisdictions except the U.S. and foreign jurisdictions in which income tax expense or benefit continues to be offset by adjustments to the valuation allowances. Our effective tax rate is calculated using projected annual pre-tax income or loss from continuing operations and is affected by research tax credits, the expected level of other tax benefits, the effects of business acquisitions and dispositions, the impact of changes to valuation allowances, changes in other comprehensive income, as well as changes in the mix of income and losses in the jurisdictions in which we operate that have varying statutory rates.

In the U.S., the tax years remain open back to the year 2000. In other major jurisdictions where we conduct business, the tax years generally remain open back to the year 2003. It is reasonably possible that changes to our unrecognized tax benefits could be significant in the next twelve months due to lapses of statutes of limitation and tax audit settlements. As a result of uncertainties regarding the timing of the completion of tax audits in various jurisdictions and their possible outcomes, an estimate of the range of increase or decrease that could occur in the next twelve months cannot be made.

Our U.S. federal income tax returns for 2000 through 2007 have been or are under audit by the IRS. In August 2007, we received a RAR for 2000 through 2002. In the RAR, the IRS proposes to assess a net tax deficiency, after applying available net operating losses from the years under audit and undisputed tax credits, for those years of approximately $405 million, plus penalties of approximately $160 million and interest. If the IRS were to fully prevail, our net operating loss and tax credits generated in recent years would be utilized earlier than they otherwise would have been, and our annual effective tax rate would increase in the period the IRS prevails. The RAR addresses several issues. One issue, however, relating to the use of Agilent's brand name by our foreign affiliates,

accounts for a majority of the claimed tax deficiency. We believe that the claimed IRS adjustment for this issue in particular is inconsistent with applicable tax laws and that we have meritorious defenses to this claim. Therefore, we have not included any tax for this item in our tax provisions. We filed a formal protest, and in the protest, we vigorously opposed the claim associated with Agilent's brand name, and most of the other claimed adjustments proposed in the RAR. In April of 2008, we received a rebuttal to our formal protest, and after reviewing the IRS's arguments, our assessment of the risks remains the same. In the formal protest, we also requested a conference with the Appeals Office of the IRS, and we recently began to address these matters with them. The final resolution of the proposed adjustments is uncertain and may take several years. Based on current information, it is our opinion that the ultimate disposition of these matters is unlikely to have a material adverse effect on our consolidated financial position, results of operations or liquidity.

Segment Overview

Agilent is a measurement company providing core bio-analytical and electronic measurement solutions to the communications, electronics, life sciences and chemical analysis industries. Agilent has three primary businesses focused on the electronic measurement market and the bio-analytical measurement market and the semiconductor and board test market.

Upon the adoption of SFAS No. 123 (R) in the first quarter of 2006, we included share-based compensation expense in our GAAP results but did not include such expense in our segment reporting. In the third quarter of 2008, we included share-based compensation expense in our segment results. All segment numbers have been reclassified to conform to the current period presentation.

In the first quarter of 2009, we formed a new operating segment from our existing businesses; the semiconductor and board test segment. The new segment covers semiconductor equipment and services sold to semiconductor manufacturing and printed circuit board assembly customers. The semiconductor and board test segment combines laser interferometer, parametric test and printed circuit board manufacturing test equipment. Laser interferometer was formerly part of the . . .