Keysight Technologies, Inc. — Q3 FY2020 Form 10-Q
Reporting period: Three and nine months ended July 31, 2020. Amounts are in millions of dollars except per-share data. Keysight supplies electronic design, test and measurement solutions and related services. Its reportable segments are Communications Solutions Group (CSG) and Electronic Industrial Solutions Group (EISG).
Financial performance
| Metric | Q3 FY2020 | Q3 FY2019 | Nine months FY2020 | Nine months FY2019 |
|---|---|---|---|---|
| Revenue | $1,011 | $1,087 | $3,001 | $3,183 |
| Gross margin | 59.9% | 59.1% | 59.2% | 58.7% |
| Operating income | $182 | $197 | $487 | $503 |
| Operating margin | 18.0% | 18.2% | 16.2% | 15.8% |
| Net income | $176 | $159 | $410 | $426 |
| Diluted EPS | $0.93 | $0.83 | $2.16 | $2.23 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $678 | $735 |
- Q3 revenue comprised $813 of products and $198 of services and other. Products fell 10% year over year; services and other increased 8%.
- Q3 orders were $1,067, down 4% year over year; nine-month orders were $3,297, up 2%.
- Nine-month capital expenditures were $87; investing cash flow was negative $379, including $324 net cash used for acquisitions. Financing cash flow was negative $198, including $196 of treasury-stock repurchases.
- At July 31, cash and cash equivalents were $1,697, plus $6 of restricted cash. Current assets were $3,278 and current liabilities $980. Long-term debt was $1,789; no revolving-facility borrowings were outstanding. The $450 revolving facility expires February 2022.
Changes and drivers
- Revenue declined 7% in Q3 and 6% for the first nine months, principally due to COVID-19-related site closures and supply-chain disruption. Q3 revenue fell 4% in CSG and 15% in EISG; nine-month revenue fell 5% and 9%, respectively.
- Gross margin improved by 1 percentage point in both comparable periods, supported by favorable mix and lower variable people costs. Operating margin was essentially flat year over year for the nine-month period; Q3 operating margin was down 0.2 percentage point.
- Q3 net income increased despite lower revenue, mainly reflecting a lower tax provision, favorable mix and reduced variable and discretionary spending. Nine-month net income decreased, primarily due to lower revenue volume.
- Nine-month operating cash flow decreased $57 from the prior year. The filing attributes the decline in part to lower deferred-revenue inflows, lower variable compensation accruals and reduced wildfire-related insurance recoveries.
Outlook, risks and unusual items
- Management expects COVID-19-related demand and supply-chain headwinds to continue over the next few quarters, while citing ongoing demand in selected areas such as 5G, 400G and advanced semiconductor processes. Demand was weaker in automotive and general electronics, including education. The filing provides no numerical revenue or EPS guidance.
- Management expects fiscal 2020 capital spending of approximately $115. It believes cash, operating cash generation and access to capital markets and credit lines will meet liquidity needs for at least 12 months.
- Cost and liquidity actions included a temporary hiring freeze, reduced discretionary spending and variable compensation, and lower outsourced manufacturing costs. R&D investment continued.
- Keysight acquired Eggplant in Q3 for $319 net of $11 cash acquired. The preliminary allocation included $280 of goodwill and $88 of other intangible assets. Integration and realization of acquisition benefits remain risks.
- Nine-month results included a $32 operating gain from $37 of insurance proceeds related to 2017 Northern California wildfire damage; management expected no further material wildfire-related proceeds or expenses. The unusually low Q3 effective tax rate of 4.7% included a $10 discrete tax benefit; the nine-month rate was 17.2%, including a $5 discrete benefit. Management estimated a fiscal 2020 annual effective rate of 18.1%, excluding discrete items.
- Keysight had paid $68 of Malaysian taxes and penalties related to a 2008 assessment and had appealed to the High Court. Management cited defenses, but the outcome remains uncertain. The filing also identifies COVID-19, global economic weakness, trade/export restrictions, supply-chain dependence, customer spending, acquisitions, cybersecurity and tax matters among significant risks.
- Cash-flow hedges included forward-starting interest-rate swaps with $600 notional tied to anticipated debt issuances through fiscal 2024. The filing reported no material pending legal matters believed reasonably likely to materially affect the company.
Important facts for investors to verify
- Whether revenue, orders and margins recover as pandemic-related closures and supply-chain constraints ease, particularly across EISG and weaker end markets.
- Whether operating cash generation remains sufficient amid working-capital movements, acquisition spending, repurchases and expected capital expenditures.
- Eggplant’s integration, purchase-price allocation and contribution to growth, given the material goodwill and intangible assets recorded.
- The status and potential financial impact of the Malaysian tax appeal, tax-incentive renewals and other open tax examinations.
- Debt maturities, covenant compliance and the company’s capital-allocation plans; $215 of the authorized $500 repurchase program remained available at July 31, 2020.