UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

(MARK ONE) 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. 

FOR THE TRANSITION PERIOD FROM              TO        

 

AGILENT TECHNOLOGIES, INC.

TABLE OF CONTENTS

 

 

 

 

 

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

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

 

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

 

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

 

Our fiscal year-end is October 31, and our fiscal quarters end on January 31, April 30 and July 31. Unless otherwise stated, these dates refer to our fiscal year and fiscal quarters.

In the opinion of management, the accompanying condensed consolidated financial statements contain all normal and recurring adjustments necessary for a fair statement of our condensed consolidated balance sheet as of JanuaryJuly 31, 2018 and October 31, 2017, condensed consolidated statement of comprehensive income (loss) for the three and nine months ended JanuaryJuly 31, 2018 and 2017, condensed consolidated statement of operations for the three and nine months ended JanuaryJuly 31, 2018 and 2017, and condensed consolidated statement of cash flows for the threenine months ended JanuaryJuly 31, 2018 and 2017.

because of their short maturities. The fair value of long-term equity investments is determined using quoted market prices for those securities when available. The fair value of our senior notes, calculated from quoted prices which are primarily Level 1 inputs under the accounting guidance fair value hierarchy is lower than the carrying value by approximately $11 million as of July 31, 2018 and exceeds the carrying value by approximately $25 million and $58 million as of January 31, 2018 and October 31, 2017, respectively.2017. The change in the excess of fair value over carrying value in the threenine months ended JanuaryJuly 31, 2018 is primarily due to fluctuations in market interest rates. The fair value of foreign currency contracts used for hedging purposes is estimated internally by using inputs tied to active markets. These inputs, for example, interest rate yield curves, foreign exchange rates, and forward and spot prices for currencies are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. See also Note 8, "Fair Value Measurements" for additional information on the fair value of financial instruments.

 2. NEW ACCOUNTING PRONOUNCEMENTS

There were no changes to the new accounting pronouncements not yet adopted as described in our Annual Report on Form 10-K for the fiscal year ended October 31, 2017 except for the following:

In February 2018,May 2014, the Financial Accounting Standards Board ("FASB") issued new revenue recognition guidance, Accounting Standard Codification Topic 606, Revenue from contract with customers, which provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most current revenue recognition guidance. The objective of the new revenue standard is to significantly enhance comparability and clarify principles of revenue recognition practices across entities, industries, jurisdictions and capital markets. The guidance is effective for us at the beginning of our fiscal year 2019. We expect to adopt this standard on November 1, 2018 through the application of the modified retrospective method reflecting the cumulative effect of initially applying the new guidance to revenue recognition in the first quarter of fiscal 2019. Under the new guidance, there are specific criteria to determine if a performance obligation should be recognized over time or at a point in time. We expect that in some cases the revenue recognition timing under the new guidance will change from current practice.  We are currently evaluating the impact the adoption of this standard will have on our consolidated financial statements and disclosures.

In February 2018, the FASB issued amendments to reporting comprehensive income to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act that was enacted in December 2017 that reduced the U.S. federal corporate income tax rate and made other changes to U.S. federal tax laws. The amendments in this update also require certain disclosures about stranded tax effects. The amendments are effective for us beginning November 1, 2019, and for interim periods within that fiscal year and should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. Early adoption ofWe expect to adopt this guidance is permitted.on November 1, 2018. We are currently evaluating the timingimpact the adoption of this guidance will have on our consolidated financial statements and disclosures.

In February 2018, the FASB issued technical corrections and improvements to amendments published in January 2016 to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The provisions under these corrections and improvements are effective for us beginning November 1, 2018, and for interim periods within that year. Early adoption is not permitted. We currently do not expect this guidance to have a material impact on our consolidated financial statements and disclosures.

In March 2018, the FASB issued amendments to SEC Staff Accounting Bulletin (“SAB”) No. 118. These amendments modified certain SEC material in Topic 740 for the income tax accounting implications of the recently issued Tax Act and generally serves to codify the SEC’s guidance released in SAB No. 118. These amendments are effective for us beginning November 1, 2018, and interim periods with that year. We are currently finalizing the impact the adoption of this guidance will have on our consolidated financial statements and disclosures.

Other amendments to GAAP in the U.S. that have been issued by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.

3.     SHARE-BASED COMPENSATION

 

Agilent accounts for share-based awards in accordance with the provisions of the authoritative accounting guidance which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors including employee stock option awards, restricted stock units, employee stock purchases made under our employee stock purchase plan (“ESPP”) and performance share awards granted to selected members of our senior management under the long-term performance plan (“LTPP”) based on estimated fair values.

Participants in the LTPP are entitled to receive unrestricted shares of the company's stock after the end of a three-year period, if specified performance targets are met. Certain LTPP awards are generally designed to meet the criteria of a performance award with the performance metrics and peer group comparison based on the Total Stockholders’ Return (“TSR”) set at the beginning of the performance period. Effective November 1, 2015, the Compensation Committee of the Board of Directors approved another type of performance stock award, for the company's executive officers and other key employees. Participants in this program are also entitled to receive unrestricted shares of the company's stock after the end of a three-year period, if specified performance targets over the three-year period are met. The performance target for grants made in 2016 were based on Operating Margin (“OM”) and the performance grants made in 2017 and 2018 were based on Earnings Per Share ("EPS"). The performance targets for the LTPP-EPS grants for year 2 and year 3 of the performance period will beare set in the first quarter of year 2 and year 3, respectively. All LTPP awards granted after November 1, 2015, are subject to a one-year post-vest holding period.

The final LTPP award may vary from zero to 200 percent of the target award. The maximum award value for awards granted in 2016 and 2017 cannot exceed 300 percent of the grant date target value. We consider the dilutive impact of these programs in our diluted net income per share calculation only to the extent that the performance conditions are expected to be met. Restricted stock units generally vest, with some exceptions, at a rate of 25 percent per year over a period of four years from the date of grant.

                                               

The impact on our results for share-based compensation was as follows:

 

 

Shares granted under the LTPP (TSR) were valued using a Monte Carlo simulations model. The Monte Carlo simulation fair value model requires the use of highly subjective and complex assumptions, including the price volatility of the underlying stock.  For the volatility of our 2017 and 2018 LTPP (TSR) grants, we used our own historical stock price volatility.  

The ESPP allows eligible employees to purchase shares of our common stock at 85 percent of the closing market price at purchase date and uses the purchase date to establish the fair market value.

The estimated fair value of restricted stock units, LTPP (OM) and LTPP (EPS) awards 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.

All awards granted in 2016 and thereafter 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 (see table above). The model calculates the potential lost value if the employee were able to sell the shares during the lack of marketability period, instead of being required to hold the shares. The model used the same historical stock price volatility and dividend yield assumption used for the Monte Carlo simulations model and an expected dividend yield to compute the discount.

4.     INCOME TAXES

For the three and nine months ended JanuaryJuly 31, 2018, the company's income tax expense was $553$6 million with an effective tax rate of 237.3 percent. Our2.5 percent and $581 million with an effective tax rate of 82.8 percent, respectively. For the nine months ended July 31, 2018, our effective tax rate and the resulting provision for income taxes were significantly impacted by the discrete charge of $533 million related to the enactment of the U.S. Tax Cuts and Jobs Act (the “Tax Act”) as discussed below. The income taxesU.S. statute of limitation for audit of tax returns for fiscal year 2014 expired in July 2018. The statute expiration resulted in the recognition of previously unrecognized tax benefits of $23 million for the three and nine months ended JanuaryJuly 31, 2018. The income tax provision for the nine months ended July 31, 2018 also includes the excess tax benefits of $11 million from stock based compensation.compensation of $17 million.

For the three and nine months ended JanuaryJuly 31, 2017, the company's income tax expense was $25$18 million with an effective tax rate of 13.0 percent.9.3 percent and $70 million with an effective tax rate of 12.1 percent, respectively. The income tax provision for the three and nine months ended JanuaryJuly 31, 2017 included net discrete tax benefits of $2 million.$60 million and $63 million, respectively.  The significant component of the net discrete tax benefit for the three and nine months ended JanuaryJuly 31, 2017 included a $11$51 million tax expense relatedbenefit due to an employee pension settlement gain and $7 million of tax benefit for the settlement of an audit in Italy.

On December 22, 2017, the Tax Cuts and Jobs Act ("Tax Act") was enacted into law. The Tax Act enacted significant changes affecting our fiscal year 2018, including, but not limited to, (1) reducing the U.S. federal corporate tax rate and (2) imposing a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries that had not been previously taxed in the U.S.

The Tax Act also establishes new tax provisions affecting our fiscal year 2019, including, but not limited to, (1) creating a new provision designed to tax global intangible low-tax income (“GILTI”); (2) generally eliminating U.S. federal taxes on dividends from foreign subsidiaries; (3) eliminating the corporate alternative minimum tax (“AMT”); (4) creating the base erosion anti-abuse

tax (“BEAT”); (5) establishing a deduction for foreign derived intangible income ("FDII"); (6) repealing domestic production activity deduction; and (7) establishing new limitations on deductible interest expense and certain executive compensation.

The Tax Act reducesreduced the U.S. federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Due to our fiscal year end, the lower corporate tax rate will be phased in, resulting in a U.S. statutory federal rate of 23 percent for our fiscal year ending October 31, 2018 and 21 percent for subsequent fiscal years.

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 ("SAB 118")which allows companies to record provisional amounts during a measurement period not extending beyond one year from the Tax Act enactment date. As ofDuring the three months ended January 31, 2018, the company has not completed the accounting for all the impacts of the Tax Act. During the quarter, the company recognized a provisional amount of $533 million which includes (1) an estimated provision of $480 million of U.S. transition tax and correlative items on deemed repatriated earnings of non-U.S. subsidiaries and (2) an estimated provision of $53 million associated with the impact of decreased U.S. corporate tax rate as described below. As of July 31, 2018, the company has not completed the accounting for all the impacts of the Tax Act. We were able to reasonably estimate certain effects and, therefore, recorded provisional adjustments associated with the Tax Act in the three months ended January 31, 2018, and they remain unchanged as of July 31, 2018.

where the company conducts business, the tax years generally remain open back to the year 2001. There were no other substantial changes from our 2017 Annual Report on Form 10-K to the status of the open tax years in the first threenine months of fiscal year 2018. In the U.S., tax years remain open back to the year 2014 for federal income tax purposes and the year 2000 for significant states. In other major jurisdictions where the company conducts business, the tax years generally remain open back to the year 2001.

With these jurisdictions and the U.S., itIt is reasonably possible there could be significant changes to our unrecognized tax benefits in the next twelve months due to either the expiration of a statute of limitation or a tax audit settlement. Given the number of years and numerous matters that remain subject to examination in various tax jurisdictions, management is unable to estimate the range of possible changes to the balance of our unrecognized tax benefits.

5. NET INCOME PER SHARE

 

The following is a reconciliation of the numerator and denominator of the basic and diluted net income per share computations for the periods presented below:

 

The dilutive effect of share-based awards is reflected in diluted net income per share by application of the treasury stock method, which includes consideration of unamortized share-based compensation expense and the dilutive effect of in-the-money options and non-vested restricted stock units. Under the treasury stock method, the amount the employee must pay for exercising stock options and unamortized share-based compensation expense collectively are assumed proceeds to be used to repurchase hypothetical shares. An increase in the fair market value of the company's common stock can result in a greater dilutive effect from potentially dilutive awards.

We exclude stock options with exercise prices greater than the average market price of our common stock from the calculation of diluted earnings per share because their effect would be anti-dilutive. In addition, we exclude from the calculation of diluted earnings per share stock options, ESPP, LTPP and restricted stock awards whose combined exercise price and unamortized fair value were greater than the average market price of our common stock because their effect would also be anti-dilutive.  

For the three and nine months ended JanuaryJuly 31, 2018, and 2017, the diluted net loss per share isimpact of the same as basic net loss per share as the effects of all 6.7 millionanti-dilutive potential common shares outstanding would be anti-dilutive. For the three months ended January 31, 2017, no potential common sharesthat were excluded from the calculation of diluted earnings per share.share was not material.

7. GOODWILL AND OTHER INTANGIBLE ASSETS

 

 

 

During the threenine months ended JanuaryJuly 31, 2018, we recorded additions to goodwill of $5$329 million and additions to other intangible assets of $2$233 million related to an acquisition. During the three months ended January 31, 2018,five acquisitions. There was no foreign exchange translation impact on other intangible assets, net increased $4during the nine months ended July 31, 2018. We also acquired approximately $1 million dueof third party technologies and licenses during the nine months ended July 31, 2018. During the nine months ended July 31, 2018, we also transferred $7 million from in-process R&D to the impactpurchased technology on completion of foreign exchange translation.an R&D project related to an acquisition.

Each quarter we review the events and circumstances to determine if impairment of indefinite-lived intangible assets and goodwill is indicated. There were no indicators of impairments of indefinite-lived intangible assets or goodwill during the three and nine months ended JanuaryJuly 31, 2018 and 2017, respectively.

Amortization expense of intangible assets was $26$28 million and $32$80 million for the three and nine months ended JanuaryJuly 31, 2018, respectively. Amortization expense of intangible assets was $28 million and $92 million for the three and nine months ended July 31, 2017, respectively.

Future amortization expense related to existing finite-lived purchased intangible assets for the remainder of fiscal year 2018 and for each of the five succeeding fiscal years and thereafter is estimated below:

 

8. FAIR VALUE MEASUREMENTS

 

The authoritative guidance defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, we consider the principal or most advantageous market and assumptions that market participants would use when pricing the asset or liability.

Fair Value Hierarchy

The guidance establishes a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into three levels. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. There are three levels of inputs that may be used to measure fair value:

 

Financial assets and liabilities measured at fair value on a recurring basis as of JanuaryJuly 31, 2018 were as follows:

 

 

 

Our money market funds and trading securities investments are generally valued using quoted market prices and therefore are classified within level 1 of the fair value hierarchy. Our derivative financial instruments are classified within level 2, as there is not an active market for each hedge contract, but the inputs used to calculate the value of the instruments are tied to active

markets. Our deferred compensation liability is classified as level 2 because, although the values are not directly based on quoted market prices, the inputs used in the calculations are observable.

Trading securities, which is comprised of mutual funds, bonds and other similar instruments, and deferred compensation liability are reported at fair value, with gains or losses resulting from changes in fair value recognized currently in net income.

 

For the three and nine months ended JanuaryJuly 31, 2018 and 2017, there were no impairments of long-lived assets held and used or long-lived assets held for sale.

9. DERIVATIVES

 

We are exposed to foreign currency exchange rate fluctuations and interest rate changes in the normal course of our business. As part of our risk management strategy, we use derivative instruments, primarily forward contracts, purchased options to hedge economic and/or accounting exposures resulting from changes in foreign currency exchange rates.

 

 

 

On August 9, 2011, we terminated five interest rate swap contracts related to our 2020 senior notes that represented the notional amount of $500 million. The remaining gain to be amortized at JanuaryJuly 31, 2018 was $10$8 million. All deferred gains from terminated interest rate swaps are being amortized over the remaining life of the respective senior notes.

 

 

be amortized related to the treasury lock agreements at JanuaryJuly 31, 2018 was $2$1 million.

In February 2016, Agilent executed three forward-starting pay fixed/receive variable interest rate swaps for the notional amount of $300 million in connection with future interest payments to be made on our 2026 senior notes issued on September 15, 2016. These derivative instruments were designated and qualified as cash flow hedges under the criteria prescribed in the

 

Additionally, we enter into foreign exchange contracts to hedge monetary assets and liabilities that are denominated in currencies other than the functional currency of our subsidiaries. These foreign exchange contracts are carried at fair value and do not qualify for hedge accounting treatment and are not designated as hedging instruments. Changes in value of the derivative are recognized in other income (expense) in the condensed consolidated statement of operations, in the current period, along with the offsetting foreign currency gain or loss on the underlying assets or liabilities.

 

Our use of derivative instruments exposes us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. We do, however, seek to mitigate such risks by limiting our counterparties to major financial institutions which are selected based on their credit ratings and other factors.  We have established policies and procedures for mitigating credit risk that include establishing counterparty credit limits, monitoring credit exposures, and continually assessing the creditworthiness of counterparties.

A number of our derivative agreements contain threshold limits to the net liability position with counterparties and are dependent on our corporate credit rating determined by the major credit rating agencies. The counterparties to the derivative instruments may request collateralization, in accordance with derivative agreements, on derivative instruments in net liability positions.

 

The effect of derivative instruments for foreign exchange contracts designated as hedging instruments and not designated as hedging instruments in our consolidated statement of operations were as follows:

We do not expect to contribute to our U.S. defined benefit plans during the remainder of 2018 and we expect to contribute $17$8 million to our non-U.S. defined benefit plans during the remainder of 2018.

11. WARRANTIES AND CONTINGENCIES

 

 

We accrue for standard warranty costs based on historical trends in warranty charges as a percentage of net product shipments. The accrual is reviewed regularly and periodically adjusted to reflect changes in warranty cost estimates. Estimated warranty charges are recorded within cost of products at the time products are sold. The standard warranty accrual balances are held in other accrued and other long-term liabilities on our condensed consolidated balance sheet. Our standard warranty terms typically extend to one year from the date of delivery, depending on the product.

A summary of the standard warranty accrual activity is shown in the table below:

 

 

 

We are involved in lawsuits, claims, investigations and proceedings, including, but not limited to, intellectual property, commercial and employment matters, which arise in the ordinary course of business. There are no matters pending that we currently believe are probable and reasonably possible of having a material impact to our business, consolidated financial condition, results of operations or cash flows.

12. SHORT-TERM DEBT

 

 

On September 15, 2014, Agilent entered into a credit agreement with a group of financial institutions which provides for a $400 million five-year unsecured credit facility that will expire on September 15, 2019. On June 9, 2015, the commitments under the existing credit facility were increased by $300 million and on July 14, 2017, the commitments under the existing credit facility were increased by an additional $300 million so that the aggregate commitments under the facility now total $1 billion. As of JanuaryJuly 31, 2018, the company had no borrowings of $345 million outstanding under the credit facility. We were in compliance with the covenants for the credit facility during the three and nine months ended JanuaryJuly 31, 2018.

In October 2007, the company issued an aggregate principal amount of $600 million in senior notes ("2017 senior notes"). On October 20, 2014, we settled the redemption of $500 million of the $600 million outstanding aggregate principal amount of our 2017 senior notes. The remaining $100 million in senior notes matured on November 1, 2017 and were paid in full.

13. LONG-TERM DEBT

 

 

The following table summarizes the company’s long-term senior notes and the related interest rate swaps:

 

 

14. STOCKHOLDERS' EQUITY

 

Stock Repurchase Program

 

On May 28, 2015, we announced that our board of directors had approved a new share repurchase program (the "2015 repurchase program"). The 2015 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 three and nine months ended JanuaryJuly 31, 2018, we repurchased 674,000and retired approximately 3.8 million shares for $47$243 million and 5.1 million shares for $336 million, respectively, under this authorization. As of January 31, 2018, we retired approximately 637,000 shares and the remaining 37,000 shares as of January 31, 2018 were retired in February 2018. During the three and nine months ended JanuaryJuly 31, 2017, we repurchased and retired approximately 2.5zero shares and 4.1 million shares for $111$194 million, respectively, under this authorization. As of JanuaryJuly 31, 2018, we had remaining authorization to repurchase up to $563$274 million of our common stock under this program.

 

Cash Dividends on Shares of Common Stock